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 March 31, 2010





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. Employerincorporation or organization)
            Identification No.)





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





(919) 765-5000


(Registrant’s
telephone number, including area code)


_________________





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 has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).  Yes  ̈
        No  ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.





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





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





As of May
11, 2010, there were approximately 18,342,542 shares of the registrant’s common
stock, par value $0.001 per share, outstanding.











SMART
ONLINE, INC.





FORM
10-Q


For the
Quarterly Period Ended March 31, 2010





TABLE
OF CONTENTS





Page
      No.PART
      I – FINANCIAL INFORMATIONItem
      1.
            Financial
      StatementsBalance
      Sheets as of March 31, 2010 (unaudited) and December 31,
    2009
            3Statements
      of Operations (unaudited) for the three months ended March 31, 2010 and
      2009
            4Statements
      of Cash Flows (unaudited) for the three months ended March 31, 2010 and
      2009
            5Notes
      to Financial Statements (unaudited)
            6Item
      2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            18Item
      3.
            Quantitative
      and Qualitative Disclosures About Market Risk
            32Item
      4.
            Controls
      and Procedures
            32Item
      4T.
            Controls
      and Procedures
            32PART
      II – OTHER INFORMATIONItem
      1.
            Legal
      Proceedings
            33Item
      1A.
            Risk
      Factors
            33Item
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            38Item
      6.
            Exhibits
            39Signatures
            41





2





PART
I – FINANCIAL INFORMATION





Item
1.              Financial
Statements


SMART ONLINE, INC.


BALANCE
SHEETS





March 31,
              2010
              (unaudited)
            
            
            December 31,
              2009ASSETSCurrent
      assets:Cash
      and cash equivalents
            
            $
            22,477
            
            
            $
            119,796Accounts
      receivable, net
            
            
            -
            
            
            
            13,056Note
      receivable
            
            
            -
            
            
            
            -Prepaid
      expenses
            
            
            222,710
            
            
            
            240,840Total
      current assets
            
            
            245,187
            
            
            
            373,692Property
      and equipment, net
            
            
            243,075
            
            
            
            258,450Capitalized
      software, net
            
            
            433,509
            
            
            
            450,782Unbilled
      receivable, non-current
            
            
            -
            
            
            
            -Prepaid
      expenses, non-current
            
            
            73,800
            
            
            
            110,700Intangible
      assets, net
            
            
            150,000
            
            
            
            150,000Other
      assets
            
            
            1,095
            
            
            
            2,496TOTAL
      ASSETS
            
            $
            1,146,666
            
            
            $
            1,346,120LIABILITIES
      AND STOCKHOLDERS’ EQUITY (DEFICIT)Current
      liabilities:Accounts
      payable
            
            $
            752,800
            
            
            $
            518,309Notes
      payable
            
            
            2,147,183
            
            
            
            1,964,281Deferred
      revenue
            
            
            27,215
            
            
            
            40,115Accrued
      liabilities – Nouri
            
            
            1,802,379
            
            
            
            1,802,379Accrued
      liabilities
            
            
            2,432,503
            
            
            
            2,623,959Total
      current liabilities
            
            
            7,162,080
            
            
            
            6,949,043Long-term
      liabilities:Notes
      payable
            
            
            10,279,790
            
            
            
            9,785,255Deferred
      revenue
            
            
            11,940
            
            
            
            5,601Total
      long-term liabilities
            
            
            10,291,730
            
            
            
            9,790,856Total
      liabilities
            
            
            17,453,810
            
            
            
            16,739,899Commitments
      and contingenciesStockholders’
      equity (deficit):Preferred
      stock, $0.001 par value, 5,000,000 shares authorized, no shares issued and
      outstanding at March 31, 2009 and December 31, 2008
            
            
            -
            
            
            
            -Common
      stock, $0.001 par value, 45,000,000 shares authorized, 18,342,542 and
      18,333,122 shares issued and outstanding at March 31, 2010 and December
      31, 2009, respectively
            
            
            18,343
            
            
            
            18,333Additional
      paid-in capital
            
            
            67,040,385
            
            
            
            67,036,836Accumulated
      deficit
            
            
            (83,365,872
            )
            
            
            (82,448,948
            )Total
      stockholders’ deficit
            
            
            (16,307,144
            )
            
            
            (15,393,779
            )TOTAL
      LIABILITIES AND STOCKHOLDERS’ DEFICIT
            
            $
            1,146,666
            
            
            $
            1,346,120





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




3




SMART
ONLINE, INC.


STATEMENTS
OF OPERATIONS


(unaudited)




Three Months EndedMarch 31,
              2010
            
            
            March 31,
              2009REVENUES:Subscription
      fees
            
            $
            136,258
            
            
            $
            241,782Professional
      service fees
            
            
            62,775
            
            
            
            118,773License
      fees
            
            
            87,800
            
            
            
            11,250Hosting
      fees
            
            
            44,272
            
            
            
            72,211Other
      revenue
            
            
            32,795
            
            
            
            37,671Total
      revenues
            
            
            363,900
            
            
            
            481,687COST
      OF REVENUES
            
            
            365,934
            
            
            
            492,601GROSS
      PROFIT
            
            
            (2,034
            )
            
            
            (10,914
            )OPERATING
      EXPENSES:Sales
      and marketing
            
            
            152,635
            
            
            
            299,539Research
      and development
            
            
            32,005
            
            
            
            276,879General
      and administrative
            
            
            672,419
            
            
            
            895,590Total
      operating expenses
            
            
            857,059
            
            
            
            1,472,008LOSS
      FROM OPERATIONS
            
            
            (859,093
            )
            
            
            (1,482,922
            )OTHER
      INCOME (EXPENSE):Interest
      expense, net
            
            
            (210,695
            )
            
            
            (127,998
            )Gain
      on legal settlements, net
            
            
            152,863
            
            
            
            6,000Other
      income
            
            
            -
            
            
            
            10,267Total
      other expense
            
            
            (57,832
            )
            
            
            (111,731
            )NET
      LOSS
            
            $
            (916,925
            )
            
            $
            (1,594,653
            )NET
      LOSS PER COMMON SHARE:Basic
      and fully diluted
            
            $
            (0.05
            )
            
            $
            (0.09
            )WEIGHTED-AVERAGE
      NUMBER OF SHARES USED IN COMPUTING NET LOSS PER COMMON
    SHARE:Basic
      and fully diluted
            
            
            18,342,542
            
            
            
            18,333,518





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




4





SMART
ONLINE, INC.


STATEMENTS
OF CASH FLOWS


(unaudited)





Three Months EndedMarch 31,
              2010
            
            
            March 31,
              2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
            
            $
            (916,925
            )
            
            $
            (1,594,653
            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
            
            
            16,209
            
            
            
            164,288Amortization
      of deferred financing costs
            
            
            -
            
            
            
            -Provision
      for doubtful accounts
            
            
            179,517
            
            
            
            223,993Equity-based
      compensation
            
            
            3,561
            
            
            
            53,144Gain
      on disposal of assets
            
            
            -
            
            
            
            (10,267
            )Changes
      in assets and liabilities:Accounts
      receivable
            
            
            (121,343
            )
            
            
            44,435Notes
      receivable
            
            
            (45,118
            )
            
            
            (3,250
            )Prepaid
      expenses
            
            
            55,029
            
            
            
            79,556Other
      assets
            
            
            1,401
            
            
            
            (1,251
            )Accounts
      payable
            
            
            234,492
            
            
            
            10,417Deferred
      revenue
            
            
            (6,561
            )
            
            
            (47,951
            )Accrued
      and other expenses
            
            
            (191,456
            )
            
            
            196,647Net
      cash used in operating activities
            
            
            (791,194
            )
            
            
            (884,892
            )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of property and equipment
            
            
            (835
            )
            
            
            (14,565
            )Proceeds
      from sale of equipment
            
            
            -
            
            
            
            45,362Capitalized
      software
            
            
            17,273
            
            
            
            (114,078
            )Net
      cash provided by (used in) investing activities
            
            
            16,438
            
            
            
            (83,281
            )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from debt borrowings
            
            
            1,982,698
            
            
            
            2,925,511Repayments
      of debt borrowings
            
            
            (1,305,261
            )
            
            
            (1,937,651
            )Net
      cash provided by (used in) financing activities
            
            
            677,437
            
            
            
            987,860NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            
            (97,319
            )
            
            
            19,687CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            
            119,796
            
            
            
            18,602CASH
      AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            22,477
            
            
            $
            38,289Supplemental
      disclosures of cash flow information:Cash
      paid during the period for:Interest
            
            $
            228,981
            
            
            $
            127,750Income
      taxes
            
            $
            -
            
            
            $
            10





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




5





SMART
ONLINE, INC.


NOTES
TO FINANCIAL STATEMENTS


(unaudited)





1.            SUMMARY
OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES





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





Basis of
Presentation - The financial statements as of and for the three months
ended March 31, 2010 and 2009 included in this Quarterly Report on Form
10-Q are unaudited. The balance sheet as of December 31, 2009 is obtained from
the audited financial statements as of that date. The accompanying statements
should be read in conjunction with the audited financial statements and related
notes, together with management’s discussion and analysis of financial condition
and results of operations, contained in the Company’s Annual Report on Form 10-K
for the year ended December 31, 2009 filed with the Securities and Exchange
Commission (the “SEC”) on April 15, 2010 (the “2009 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 March 31,
2010, and its results of operations and cash flows for the three months ended
March 31, 2010 and 2009. The results for the three months ended March 31, 2010
are not necessarily indicative of the results to be expected for the fiscal year
ending December 31, 2010.





The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. During the three months ended March 31, 2010
and 2009, the Company incurred net losses as well as negative cash flows, is
involved in a class action lawsuit (See Note 7, “Commitments and Contingencies,”
in the 2009 Annual Report), and had deficiencies in working capital. These
factors indicate that the Company may be unable to continue as a going
concern.





The
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts or
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. At May 11, 2010, the Company does have a
commitment from its convertible secured subordinated noteholders to purchase up
to an additional $4.65 million in convertible notes upon approval and call by
the Company’s Board of Directors. There can be no assurance that, if the
noteholders do not purchase the $4.65 million in convertible notes, the Company
will be able to obtain alternative funding. There can be no assurance that the
Company’s efforts to raise capital or increase revenue will be successful. If
these efforts are unsuccessful, the Company may have to cease operations and
liquidate the business. The Company’s continuation as a going concern
depends upon its ability to generate sufficient cash flows to meet its
obligations on a timely basis, to obtain additional financing as may be
required, and ultimately to attain profitable operations and positive cash
flows.





Significant
Accounting Policies - In the opinion of the Company’s management,
the significant accounting policies used for the three months ended March 31,
2010 are consistent with those used for the year ended December 31, 2009.
Accordingly, please refer to the 2009 Annual Report for the Company’s
significant accounting policies.





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.




6





Fair Value
of Financial
Instruments - 
U.S. GAAP requires disclosures of fair value information about financial
instruments, whether or not recognized in the balance sheet, for which it is
practicable to estimate that value. Due to the short period of time to maturity,
the carrying amounts of cash equivalents, accounts receivable, accounts payable,
accrued liabilities, and notes payable reported in the financial statements
approximate the fair value.





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





Segments
-
Segmentation is based on an entity’s internal organization and reporting of
revenue and operating income based upon internal accounting methods commonly
referred to as the “management approach.” Operating segments are defined as
components of an enterprise about which separate financial information is
available that is evaluated regularly by the chief operating decision maker in
deciding how to allocate resources and in assessing performance. The Company’s
chief operating decision maker is its Chief Executive Officer, who reviews
financial information presented on a consolidated basis. Accordingly, the
Company has determined that it has a single reporting segment and operating unit
structure.





Concentration of
Credit Risk - Financial instruments that potentially subject the Company
to concentrations of credit risk consist primarily of cash and accounts
receivable. At times, cash balances may exceed the Federal Deposit Insurance
Corporation (“FDIC”) insurable limits. See Note 6, “Major Customers and
Concentration of Credit Risk,” for further discussion of risk within accounts
receivable.





Allowance for
Doubtful Accounts - The Company maintains an allowance for doubtful
accounts for estimated losses resulting from the inability, failure, or refusal
of its customers to make required payments. The need for an allowance for
doubtful accounts is evaluated based on specifically identified amounts that
management believes to be potentially uncollectible. If actual collections
experience changes, revisions to the allowance may be required.





Additionally,
from time to time the Company, as part of its negotiated contracts, has granted
extended payment terms to its strategic partners. As payments become due under
the terms of the contract, they are invoiced and reclassified as accounts
receivable. During 2008, the Company entered into a web services agreement with
a direct-selling organization customer that provided for extended payment terms
related to both professional services and the grant of a software license. The
customer began experiencing cash flow difficulties and has since significantly
slowed its payments to the Company. In addition, the Company entered into a web
services agreement with a real estate services customer and a mail-order
pharmacy.. There are significant amounts due and unpaid under the terms of their
agreements and accordingly the Company has established reserves as described
below.





Based on
these criteria, management determined that at March 31, 2010, an allowance for
doubtful accounts of $1,002,028 was required for amounts due from customers. The
allowance is comprised of the full outstanding balance of the direct-selling
organization and mail–order pharmacy services customers’ account receivable and
the real estate customers’ note receivable.  In addition to the
allowance for doubtful accounts from customers, the Company has established an
allowance of $1,798,595 related to the Nouri legal fee advance.





Impairment of Long-Lived
Assets – We record our long-lived assets, such as intangibles, property
and equipment, at cost. We review the carrying value of our indefinite lived
intangibles for possible impairment at least annually in the fourth quarter, and
all long-lived assets whenever events or changes in circumstances indicate that
the carrying amount of assets may not be recoverable in accordance with the US
GAAP. We measure the recoverability of assets to be held and used by comparing
the carrying amount of the asset to the fair value. If we consider such assets
to be impaired, we measure the impairment as the amount by which the carrying
amount exceeds the fair value, and we recognize it as an operating expense in
the period in which the determination is made. We report assets to be disposed
at the lower of the carrying amount or fair value less costs to sell. Although
we believe that the carrying values of our long-lived assets are appropriately
stated, changes in strategy or market conditions or significant technological
developments could significantly impact these judgments and require adjustments
to recorded asset balances.





In
addition to the recoverability assessment, we also routinely review the
remaining estimated useful lives of our long-lived assets. Any reduction in the
useful-life assumption will result in increased depreciation and amortization
expense in the period when such determinations are made, as well as in
subsequent periods.




7





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





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





Under
U.S. GAAP, provided the arrangement does not require significant development,
modification, or customization, revenue is recognized when all of the following
criteria have been met:





1.     persuasive
evidence of an arrangement exists





2.     delivery
has occurred





3.     the
fee is fixed or determinable





4.     collectibility
is probable





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





Under the
provisions of U.S. GAAP, consulting, website design fees, and application
development services are accounted for separately from the license of associated
software platforms when these services have value to the customer and there is
objective and reliable evidence of fair value of each deliverable. When
accounted for separately, revenues are recognized as the services are rendered
for time and material contracts, and when milestones are achieved and accepted
by the customer for fixed-price or long-term contracts. The majority of the
Company’s consulting service contracts are on a time and material basis and are
typically billed monthly based upon standard professional service
rates.





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




8





Subscription
fees primarily consist of sales of subscriptions through private-label marketing
partners to end users. We typically have a revenue-share arrangement with these
marketing partners in order to encourage them to market our products and
services to their customers. Subscriptions are generally payable on a monthly
basis and are typically paid via credit card of the individual end user. We
accrue any payments received in advance of the subscription period as deferred
revenue and amortize them over the subscription period. In the past, we
recognized all subscription revenue on a gross basis and in accordance with our
policy to periodically review our accounting policies we determined that certain
contracts require the reporting of subscription revenue on a gross basis and
others on a net basis according to US GAAP.  On that basis, we
continue to report subscription revenue from certain contracts on a gross basis
and others on a net basis.  The net effect of this reclassification of
expenses only impacts gross revenue and certain gross expenses; it does not
change the net income.





Because
our customers generally do not have the contractual right to take possession of
the software we license or market at any time, we recognize revenue on hosting
and maintenance fees as we provide the services in accordance with US
GAAP.





Deferred
Revenue 
-

Deferred revenue consists of billings or payments received in advance of revenue
recognition, and it is recognized as the revenue recognition criteria are met.
Deferred revenue also includes certain professional service fees and license
fees where all the criteria of U.S. GAAP were not met. Deferred revenue that
will be recognized over the succeeding 12-month period is recorded as current
and the remaining portion is recorded as non-current.





Cost of
Revenues 
-
Cost of revenues primarily is composed of costs related to third-party hosting
services, salaries and associated costs of customer support and professional
services personnel, credit card processing, depreciation of computer hardware
and software used in revenue-producing activities, domain name and e-mail
registrations, and allocated development expenses and general and administrative
overhead.





The
Company allocates development expenses to cost of revenues based on time spent
by development personnel on revenue-producing customer projects and support
activities. The Company allocates general and administrative overhead such as
rent and occupancy expenses, depreciation, general office expenses, and
insurance to all departments based on headcount. As such, general and
administrative overhead expenses are reflected in cost of revenues and each
operating expense category.





Stock-Based
Compensation - Effective January 1, 2006, the Company began
recognizing stock based compensation, using the Modified Prospective Approach
based on the grant date fair value estimated in accordance with US GAAP. 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, and (ii) compensation cost
for all share-based payments that are granted subsequent to January 1,
2006. Stock-based compensation is recognized on the straight-line method over
the requisite service period. Total stock-based compensation expense recognized
was $3,561 and $53,144 for the quarters ended March 31, 2010 and 2009
respectively. No stock-based compensation was capitalized in the
consolidated financial statements.





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




The fair value of option grants under the
Company’s equity compensation plan during the years ended December 31, 2009 and
2008 were estimated using the following weighted average
assumptions:




9





Three Months Ended March 31,2010
            
            
            2009Dividend
      yield
            
            
            0.0
            %
            
            
            0.0
            %Expected
      volatility
            
            
            98.7
            %
            
            
            100.5
            %Risk-free
      interest rate
            
            
            3.19
            %
            
            
            2.00
            %Expected
      lives (years)
            
            
            4.0
            
            
            
            4.0





Dividend yield – The Company
has never declared or paid dividends on its common stock and does not anticipate
paying dividends in the foreseeable future.





Expected volatility –
Volatility is a measure of the amount by which a financial variable such as
share price has fluctuated (historical volatility) or is expected to fluctuate
(expected volatility) during a period. The Company used the Company’s monthly
historical volatility since April 2005 to calculate the expected
volatility.





Risk - free interest rate – The
risk-free interest rate is based on the published yield available on U.S.
Treasury issues with a remaining term similar to the expected life of the
option.





Expected lives – The expected
lives of the options represent the estimated period of time until exercise or
forfeiture and are based on historical experience of similar
awards.





Net Loss
Per  Share -
Basic net loss per share is computed by dividing net loss by the weighted
average number of common shares outstanding during the periods. Diluted net loss
per share is computed using the weighted average number of common and dilutive
common equivalent shares outstanding during the periods. Common equivalent
shares consist of convertible notes, stock options, and warrants that are
computed using the treasury stock method. Shares issuable upon the exercise of
stock options and warrants, totaling 1,913,615 on March 31, 2010, were excluded
from the calculation of common equivalent shares, as the impact was
anti-dilutive.





Recently Issued
Accounting Pronouncements - In April
2008, the US Financial Accounting Standards Board suggested rules
concerning the determination of the useful life of intangible assets. The
standard requires entities to consider their own historical experience in
renewing or extending similar arrangements when developing assumptions regarding
the useful lives of intangible assets and also mandates certain related
disclosure requirements. The rules are effective for fiscal years beginning
after December 15, 2008, with early adoption prohibited. The Company has
adopted the rules.





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





2.            BALANCE
SHEET ACCOUNTS





Prepaid
Expenses





In 2008,
the Company entered into a non-cancelable sublease for approximately 9,837
square feet of office space, restructured as a prime lease beginning May 1, 2010
with a termination date of September 30, 2011, for its North Carolina
headquarters.  The agreement included the conveyance of certain
furniture to the Company without a stated value and required a lump-sum, upfront
payment of $500,000 that was made in September 2008. Management has assessed the
fair market value of the furniture to be approximately $50,000, and this amount
was capitalized and is subject to depreciation in accordance with the Company’s
fixed asset policies. The remainder of the payment was recorded as prepaid
expense; with the portion, relating to rent for periods beyond the next 12
months classified as non-current, and is being amortized to rent expense over
the term of the lease.





Intangible
Assets





The
following table summarizes information about intangible assets at March 31,
2010:




10





Asset Category
            
            Value
              Assigned
            
            
            Weighted
              Average
              Amortization
              Period
              (in Years)
            
            
            Impairments
            
            
            Accumulated
              Amortization
      and Prior Impairment
            
            
            Carrying
              ValueCustomer bases
            
            $
            1,944,347
            
            
            
            6.2
            
            
            
            -
            
            
            $
            1,944,347
            
            
            $
            -Acquired
      technology
            
            
            501,264
            
            
            
            3.0
            
            
            
            -
            
            
            
            501,264
            
            
            
            -Non-compete
      agreements
            
            
            801,785
            
            
            
            4.0
            
            
            
            -
            
            
            
            801,785
            
            
            
            -Trademarks
      and copyrights
            
            
            52,372
            
            
            
            9.7
            
            
            
            -
            
            
            
            52,372
            
            
            
            -Trade
      name
            
            
            380,000
            
            
            
            N/A
            
            
            
            -
            
            
            
            230,000
            
            
            
            150,000Totals
            
            $
            3,679,768
            
            
            
            -
            
            
            
            
            
            
            $
            3,529,768
            
            
            $
            150,000





We record
our long-lived assets, such as intangibles, property and equipment, at cost. We
review the carrying value of our indefinite lived intangibles for possible
impairment at least annually in the fourth quarter, and all long-lived assets
whenever events or changes in circumstances indicate that the carrying amount of
assets may not be recoverable in accordance with the US GAAP. We measure the
recoverability of assets to be held and used by comparing the carrying amount of
the asset to future net discounted cash flows expected to be generated by the
asset. If we consider such assets to be impaired, we measure the impairment as
the amount by which the carrying amount exceeds the fair value, and we recognize
it as an operating expense in the period in which the determination is made. We
report assets to be disposed at the lower of the carrying amount or fair value
less costs to sell. Although we believe that the carrying values of our
long-lived assets are appropriately stated, changes in strategy or market
conditions or significant technological developments could significantly impact
these judgments and require adjustments to recorded asset balances.


.


Accrued
Liabilities





At March
31, 2010 and December 31, 2009,the Company has recorded a total of unpaid legal expense obligations of
$1,802,379 in connection with the Nouri Matters (defined below) based on
invoices received from the law firms of Dennis Michael Nouri and Reza Eric Nouri
(together, the “Nouris”) through March 31, 2010 which figure does not include
invoices generated but not yet received.  The Company and the Nouris
have been engaged in settlement negotiations for the settlement of the Nouris’
advancement and indemnification claims (the “Nouri Matters”) against the
Company, but no definitive agreement has yet been signed.





At March
31, 2010, the Company had accrued liabilities totaling $2,432,503. This amount
consisted of the following: $2,145,716 of liability related to the estimated
cost of settlement for the class action lawsuit, after giving effect to certain
settlement payments made during the first quarter totaling $157,000, that was
filed against the Company during 2007 (the “Class Action”), pursuant to the
terms of a tentative settlement agreement reached between the Company and the
lead plaintiff in the class action; $75,436 of liability related to the
development of the Company’s custom accounting application; $50,594 related to
hosting services; $31,804 for liabilities associated with the settlement of
office rent negotiations; $3,791 for other professional services; $20,887 for
accrued payroll; and $104,275 of convertible note interest payable.





At
December 31, 2009, the Company had accrued liabilities totaling $2,623,959. This
amount consisted primarily of $2,302,158 of liability related to the estimated
cost of settlement for the Class Action law suit based upon the tentative
settlement agreement reached between the Company and the lead plaintiff in the
class action, plus other accrued legal fees, $75,436 of liability related to the
development of the Company’s custom accounting application; $50,594 related to
hosting services; $18,174 for liabilities associated with the settlement of
office rent negotiations $3,791 for other professional services, $71,159 for
accrued payroll and $102,647 of convertible note interest payable.





Deferred
Revenue





Deferred
Revenue

-

Deferred revenue consists of billings or payments received in advance of revenue
recognition, and it is recognized as the revenue recognition criteria are met.
Deferred revenue also includes certain professional services fees and licensing
revenues where all the criteria described earlier were not met. Deferred revenue
that will be recognized over the succeeding 12-month period is recorded as
current and the remaining portion is recorded as noncurrent.





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




11




March 31,
              2010
            
            
            December 31,
              2009Subscription
      fees
            
            $
            39,155
            
            
            $
            40,115License
      fees
            
            
            -
            
            
            
            5,601Totals
            
            $
            39,155
            
            
            $
            45,716Current
      portion
            
            $
            27,215
            
            
            $
            40,115Non-current
      portion
            
            
            11,940
            
            
            
            5,601Totals
            
            $
            39,155
            
            
            $
            45,716





3.           NOTES
PAYABLE





Convertible
Notes





On
November 14, 2007, in an initial closing, the Company sold $3.3 million
aggregate principal amount of convertible secured subordinated notes (as
amended, the “Notes”) under the Convertible Secured Subordinated Note Purchase
Agreement, dated November 14, 2007 (as amended, the “Note Purchase Agreement”).
 The Notes bear an 8% interest rate and interest is paid
quarterly.





In
addition, at the initial closing, the noteholders committed to purchase on a pro
rata basis up to $5.2 million aggregate principal of Notes in future closings
upon approval and call by our Board of Directors. On August 12, 2008, we
exercised our option to sell $1.5 million aggregate principal of Notes (the
“Additional Notes”) to existing noteholders, with substantially the same terms
and conditions as the Notes sold in the initial closing (the “Initial Notes”).
In connection with the sale of the Additional Notes, the noteholders holding a
majority of the aggregate principal amount of the Notes then outstanding agreed
to increase the aggregate principal amount of Notes that they are committed to
purchase from $8.5 million to $15.3 million. On November 21, 2008, we sold
$500,000 aggregate principal amount of Notes to two new convertible noteholders
(the “New Notes”), with substantially the same terms and conditions as the
Initial Notes and the Additional Notes.  At December 31, 2008, $5.3
million aggregate principal amount of Notes were outstanding.




On
January 6, 2009, the Company sold $500,000 aggregate principal amount of Notes
to Atlas Capital SA (“Atlas”), on substantially the same terms and conditions as
the previously issued Notes.




On
February 24, 2009, the Company sold $500,000 aggregate principal amount of Notes
to Atlas on substantially the same terms and conditions as the previously issued
Notes. On the same date, the noteholders holding a majority of the aggregate
principal amount of the Notes outstanding agreed that the Company may sell up to
$6 million aggregate principal amount of Additional Notes to new convertible
noteholders or existing noteholders at any time on or before December 31, 2009
with a maturity date of November 14, 2010 or later. In addition, the maturity
date definition for each of the Notes was changed from November 14, 2010 to the
date upon which the Note is due and payable, which was the earlier of (1)
November 14, 2010, (2) a change of control, or (3) if an event of default
occurs, the date upon which noteholders accelerate the indebtedness evidenced by
the Notes. The formula for calculating the conversion price of the Notes was
also amended such that the conversion price of each outstanding note and any
additional note sold in the future would be the same and set at the lowest
applicable conversion price, as described below.




On each
of April 3, 2009 and June 2, 2009, the Company sold a Note in the principal
amount of $500,000 to Atlas on substantially the same terms and conditions as
the previously issued Notes.  On each of July 16, 2009, August 26,
2009, September 8, 2009, and October 5, 2009, the Company sold a Note in the
principal amount of $250,000 to Atlas on substantially the same terms and
conditions as the previously issued Notes.  On October 9, 2009, the
Company sold a Note in the principal amount of $250,000 to UBP, Union Bancaire
Privee, an existing noteholder, on substantially the same terms and conditions
as the previously issued Notes.  On November 6, 2009, the Company sold
a Note to Atlas in the principal amount of $500,000, on December 23, 2009 the
Company sold a Note to Atlas in the principal amount of $750,000, and on
February 11, 2010, the Company sold a Note to Atlas in the principal amount of
$500,000, all upon substantially the same terms and conditions as the previously
issued Notes.




On March
5, 2010, the Company and Atlas, as the holder of a majority of the aggregate
outstanding principal amount of the Notes (the “Requisite Percentage Holder”),
together with other noteholders, entered into the Fourth Amendment to
Convertible Secured Subordinated Note Purchase Agreement, Second Amendment to
Convertible Secured Subordinated Promissory Notes and Third Amendment to
Registration Rights Agreement (the “Fourth Amendment”).  The Fourth
Amendment extends the original maturity date of the Notes from November 14, 2010
to November 14, 2013, and amends the Note Purchase Agreement and the
Registration Rights Agreement, dated November 14, 2007, to reflect this
extension.




The
Fourth Amendment extends the original maturity date of the Notes from November
14, 2010 to November 14, 2013, and amends the Note Purchase Agreement and the
Registration Rights Agreement, dated November 14, 2007, to reflect this
extension.




The
Fourth Amendment further provides that on the earlier of the maturity date of
November 14, 2013 or a merger or acquisition or other transaction pursuant to
which our existing stockholders hold less than 50% of the surviving entity, or
the sale of all or substantially all of our assets, or similar transaction, or
event of default, each noteholder in its sole discretion shall have the option
to:




12





·
            convert
      the principal then outstanding on its notes into shares of the Company’s
      common stock, or·
            receive
      immediate repayment in cash of the notes, including any accrued and unpaid
      interest.





On April
1, 2010, the Company sold a Note to Atlas in the principal amount of $350,000,
due November 14, 2013, upon substantially the same terms and conditions as
the previously issued Notes





If a
noteholder elects to convert its Notes on the maturity date, the conversion
price will be the lowest “applicable conversion price” determined for each Note.
The “applicable conversion price” for each Note shall be calculated by
multiplying 120% by the lowest of:





·
            the
      average of the high and low prices of the Company's common stock on the
      OTC Bulletin Board averaged over the five trading days prior to the
      closing date of the issuance of such
Note,





·
            if
      the Company's common stock is not traded on the Over-The-Counter market,
      the closing price of the common stock reported on the Nasdaq National
      Market or the principal exchange on which the common stock is listed,
      averaged over the five trading days prior to the closing date of the
      issuance of such note, or





·
            the
      closing price of the Company's common stock on the OTC Bulletin Board, the
      Nasdaq National Market or the principal exchange on which the common stock
      is listed, as applicable, on the trading day immediately preceding the
      date such note is converted,





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





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





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





No fees
to third parties are payable in connection with the sale of Notes.





Lines
of Credit








On
February 20, 2008, the Company entered into a revolving credit arrangement with
Paragon Commercial Bank (“Paragon”) that was renewable on an annual basis
subject to mutual approval and delivered to Paragon a secured promissory note,
dated February 20, 2008 (the “Paragon Note”) . The total line of credit advanced
by Paragon is $2.5 million and can be used for general working capital. Any
advances made on the line of credit were required to be paid off no later than
February 19, 2009, with monthly payments being applied first to accrued interest
and then to principal. Interest accrues on the unpaid principal balance at the
Wall Street Journal’s published Prime Rate minus one-half percent. The line of
credit is secured by an irrevocable standby letter of credit in the amount of
$2.5 million issued by HSBC Private Bank (Suisse) SA (“HSBC”) with Atlas, a
current stockholder, as account party that was scheduled to expire on February
18, 2010. The Company also has agreed with Atlas that in the event of a default
by the Company in the repayment of the line of credit that results in the letter
of credit being drawn, the Company shall reimburse Atlas any sums that Atlas is
required to pay under such letter of credit. At the sole discretion of Atlas,
these payments may be made in cash by issuing shares of the Company’s common
stock at a set per-share price of $2.50 or the issuance of additional
bonds.





On
February 25, 2010, the Company entered into a Modification Agreement (the
“Modification Agreement”) with Paragon, with an effective date of February 22,
2010, relating to the Paragon Note.  The Modification Agreement
(i) extends the maturity date of the Paragon Note from February 11, 2010 to
August 11, 2010, and (ii) changes the interest rate from a variable annual rate
equal to The Wall Street Journal Prime Rate, with a floor of 5.50%, to a fixed
annual rate of 6.50%.   The Company has been advised that,
effective January 28, 2010, the expiration date of the standby letter of credit
in the amount of $2,500,000 issued by HSBC securing the Paragon Note has been
extended from February 18, 2010 to September 17, 2010.




13


As of
March 31, 2010, the Company had notes payable totaling $12,426,973. The detail
of these notes is as follows:





Note Description
            
            Short-Term
              Portion
            
            
            Long-Term
              Portion
            
            
            Total
            
            Maturity
            
            RateParagon
      Commercial Bank credit line
            
            $
            2,093,283
            
            
            $
            -
            
            
            $
            2,093,283
            
            Aug
      2010
            
            Prime, not lessthan 6.5
            %Insurance
      premium note
            
            
            21,460
            
            
            
            -
            
            
            
            21,460
            
            Jun
      2010
            
            
            5.4
            %Various
      capital leases
            
            
            32,440
            
            
            
            179,790
            
            
            
            212,230
            
            Various
            
            
            8.0-18.9
            %Convertible
      notes
            
            
            -
            
            
            
            10,100,000
            
            
            
            10,100,000
            
            Nov
      2013
            
            
            8.0
            %Totals
            
            $
            2,147,183
            
            
            $
            10,279,790
            
            
            $
            12,426,973





4.           COMMITMENTS
AND CONTINGENCIES





Lease
Commitments





The
Company leases computers, office equipment and office furniture under capital
lease agreements that expire through July 2019. Total amounts financed under
these capital leases were $272,164 and $72,164 at March 31, 2010 and 2009,
respectively, net of accumulated amortization of $59,933 and $24,883,
respectively. The current and non-current portions of the capital leases have
been recorded in current and long-term portions of notes payable on the
consolidated balance sheets as of March 31, 2010 and 2009. See also Note 3,
“Notes Payable.”





In 2008,
the Company entered into a non-cancellable sublease to relocate its North
Carolina headquarters to another facility near Research Triangle Park, under
which the Company prepaid rent in the total amount of $450,080 and purchased
existing furniture and fixtures for an additional $49,920, which furniture and
fixtures were capitalized for depreciation purposes.   Effective
May 1 , 2010, the sublease was restructured as a
direct lease with the owner of the property, with a termination date
of September 30, 2011 (the "Lease").  After taking into account the monthly
amortization of prepaid rent, the Company is obligated to make minimum
monthly rent payments in the amount of $4,208.13 during the term of the
Lease, together with a percentage of operating expenses.  The
Company includes the prepaid rent amount of $450,080 as an asset being
amortized monthly over the remaining term of the Lease.





Rent
expense for the three months ended March 31, 2010 and 2009 was $53,765 and
$43,889, respectively.




14





Development
Agreement





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. This agreement was modified on
March 26, 2008 to adjust the total number of shares issuable under the agreement
to 29,014. In 2008, the Company had paid $470,834 and issued 3,473 shares of
common stock related to this obligation.





Legal
Proceedings





At this
time, the Company is not able to determine the likely outcome of the Company’s
current pending legal matters   Management has made an initial
estimate based upon a tentative agreement for settlement of the Class Action,
its settlement discussions regarding the Nouri Matters, and its knowledge, its
experience and input from legal counsel, and the Company has accrued
approximately $3,948,095 of additional legal reserves and costs. Such amounts
will be adjusted in future periods as more information becomes available. If an
unfavorable resolution of any of these matters occurs, the Company’s business,
results of operations, and financial condition could be materially adversely
affected.





5.           STOCKHOLDERS’
EQUITY





Preferred
Stock





The Board
of Directors is authorized, without further stockholder approval, to issue up to
5,000,000 shares of $0.001 par value preferred stock in one or more series and
to fix the rights, preferences, privileges, and restrictions applicable to such
shares, including dividend rights, conversion rights, terms of redemption, and
liquidation preferences, and to fix the number of shares constituting any series
and the designations of such series. There were no shares of preferred stock
outstanding at March 31, 2010.





Common
Stock





The
Company is authorized to issue 45,000,000 shares of common stock, $0.001 par
value per share. As of March 31, 2010, it had 18,342,542 shares of common stock
outstanding. Holders of common stock are entitled to one vote for each share
held.





In March
2010, the Company issued 10,000 shares of restricted common stock
to  Mr. Shlomo Elia, for service as a Board Member.





Warrants





As
incentive to modify a letter of credit relating to the Wachovia line of credit
(see Note 3, “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 containing a
provision for cashless exercise 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. The fair value of the warrant was $734,303 as measured using the
Black-Scholes option-pricing model at the time the warrant was issued. This
amount was recorded as deferred financing costs and was amortized to interest
expense in the amount of $37,657 per month over the remaining period of the
modified line of credit, which expired in August 2008. In consideration for
Atlas providing the Paragon line of credit (see Note 3 “Notes Payable”), the
Company agreed to amend the Warrant Agreement to provide that the warrant is
exercisable within 30 business days of the termination of the Paragon line of
credit or if the Company is in default under the terms of the line of credit. If
the warrant is exercised in full, it will result in gross proceeds to the
Company of approximately $1,200,000.





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 in a private
placement.  The shares were sold at $2.55 per share pursuant to a
Securities Purchase Agreement, or the SPA, between the Company and each of the
investors.  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 expired February 21, 2010.




As part
of the commission paid to Canaccord Adams, Inc. (“CA”), the Company’s placement
agent in the transaction that closed in February 2007, 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 was obligated to file under the Investor RRA described
above, but CA was not entitled to any penalties for late registration or
effectiveness.




15





As of
March 31, 2010, warrants to purchase up to 1,655,915 shares were
outstanding.





Equity
Compensation Plans





The
Company adopted its 2004 Equity Compensation Plan (the “2004 Plan”) as of March
31, 2004. The 2004 Plan provides for the grant of incentive stock options,
non-statutory stock options, restricted stock, and other direct stock awards to
employees (including officers) and directors of the Company as well as to
certain consultants and advisors. In June 2007, the Company temporarily limited
the issuance of shares of its common stock reserved under the 2004 Plan to
awards of restricted or unrestricted stock and in June 2008 again made options
available for grant under the 2004 Plan. The total number of shares of common
stock reserved for issuance under the 2004 plan is 5,000,000 shares, subject to
adjustment in the event of a stock split, stock dividend, recapitalization, or
similar capital change.





Restricted Stock – During the
first quarter of 2010, 10,000 shares of restricted stock were issued. At March
31, 2010, there remains $62,577 of unvested expense yet to be recorded related
to all restricted stock outstanding.





Stock Options – The exercise
price for incentive stock options granted under the 2004 Plan is required to be
no less than the fair market value of the common stock on the date the option is
granted, except for options granted to 10% stockholders, which are required to
have an exercise price of not less than 110% of the fair market value of the
common stock on the date the option is granted. Incentive stock options
typically have a maximum term of ten years, except for option grants to 10%
stockholders, which are subject to a maximum term of five years. Non-statutory
stock options have a term determined by either the Board of Directors or the
Compensation Committee. Options granted under the 2004 Plan are not
transferable, except by will and the laws of descent and
distribution.





The
following is a summary of the stock option activity for the three months ended
March 31, 2010:





Shares
            
            
            Weighted
              Average
              Exercise PriceBALANCE, December
      31, 2009
            
            
            132,500
            
            
            $
            4.43Granted
            
            
            125,000
            
            
            
            1.14Exercised
            
            
            -
            
            
            
            -Canceled
            
            
            -
            
            
            
            -BALANCE,
      March 31, 2010
            
            
            257,500
            
            
            $
            2.83





The
following table summarizes information about stock options outstanding at March
31, 2010:





Currently ExercisableExercise Price
            
            
            Number of
              Options
              Outstanding
            
            
            Average
              Remaining
              Contractual
              Life (Years)
            
            
            Weighted
              Average
              Exercise
              Price
            
            
            Number of
              Shares
            
            
            Weighted
              Average
              Exercise
              Price$
            1.14
            
            
            
            125,000
            
            
            
            5.0
            
            
            $
            1.14
            
            
            
            -
            
            
            $
            -From
      $2.50 to $3.50
            
            
            
            85,000
            
            
            
            6.8
            
            
            $
            3.15
            
            
            
            83,750
            
            
            $
            3.16$
            5.00
            
            
            
            25,000
            
            
            
            4.3
            
            
            $
            5.00
            
            
            
            20,000
            
            
            $
            5.00From
      $8.61 to $9.00
            
            
            
            22,500
            
            
            
            3.5
            
            
            $
            8.61
            
            
            
            18,000
            
            
            $
            8.61Totals
            
            
            
            257,500
            
            
            
            3.6
            
            
            $
            2.84
            
            
            
            121,750
            
            
            $
            4.27





16





At March
31, 2010, there remains $54,333 of unvested expense yet to be recorded related
to all options outstanding.





Dividends - The Company has
not paid any cash dividends through March 31, 2010.





6.           MAJOR
CUSTOMERS AND CONCENTRATION OF CREDIT RISK





Financial
instruments that potentially subject the Company to credit risk principally
consist of trade receivables. The Company believes the concentration of credit
risk in its trade receivables is substantially mitigated by ongoing credit
evaluation processes, relatively short collection terms, and the nature of the
Company’s customer base, primarily mid- and large-size corporations with
significant financial histories. Collateral is not generally required from
customers. The need for an allowance for doubtful accounts is determined based
upon factors surrounding the credit risk of specific customers, historical
trends, and other information.





A
significant portion of revenues is derived from certain customer relationships.
The following is a summary of customers that represent greater than 10% of total
revenues:





Three Months Ended
              March 31, 2010Revenue Type
            
            Revenues
            
            % of Total
              RevenuesCustomer A
            Subscription fees
            
            $
            -
            
            -
            %Customer
      B
            Subscription
      fees
            
            
            111,882
            
            31
            %Customer
      C
            Subscription
      fees
            
            
            52,440
            
            14
            %Others
            Various
            
            
            199,578
            
            55
            %Total
            
            
            $
            363,900
            
            100
            %








Three Months Ended
              March 31, 2009Revenue Type
            
            Revenues
            
            % of Total
              RevenuesCustomer A
            Professional
      service fees
            
            $
            156,700
            
            33
            %Customer
      B
            Subscription
      fees
            
            
            106,294
            
            22
            %Customer
      C
            Subscription
      fees
            
            
            125,503
            
            26
            %Others
            Various
            
            
            93,190
            
            19
            %Total
            
            
            $
            481,687
            
            100
            %





As of
March 31, 2010, we had current accounts receivable of $511,593 and a note
receivable from a customer of $490,435, both of which are fully reserved. As of
December 31, 2009, one customer accounted for 91% of accounts
receivable.





7.           SUBSEQUENT
EVENTS





On April
1, 2010, the Company sold $350,000 aggregate principal amount of convertible
secured subordinated notes due November 14, 2013 to Atlas with substantially the
same terms and conditions as the previously outstanding notes, as described in
Note 3, “Notes Payable.”





In 2008, the Company
entered into a non-cancellable sublease to relocate its North Carolina
headquarters to another facility near Research Triangle Park, under which the
Company prepaid rent in the total amount of $450,080 and purchased existing
furniture and fixtures for an additional $49,920, which furniture and fixtures
were capitalized for depreciation purposes.   Effective
May 1 , 2010, the sublease was restructured as a
direct lease with the owner of the property, with a termination date
of September 30, 2011 (the "Lease").  After taking into account the monthly
amortization of prepaid rent, the Company is obligated to make minimum
monthly rent payments in the amount of $4,208.13 during the term of the
Lease, together with a percentage of operating expenses.  The
Company includes the prepaid rent amount of $450,080 as an asset being
amortized monthly over the remaining term of the Lease.




17





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





Information
set forth in this Quarterly Report on Form 10-Q contains various forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, or
the Securities Act, and Section 21E of the Securities Exchange Act of 1934, or
the Exchange Act. Forward-looking statements consist of, among other things,
trend analyses, statements regarding future events, future financial
performance, our plan to build our business and the related expenses, our
anticipated growth, trends in our business, the effect of interest rate
fluctuations on our business, the potential impact of current litigation or any
future litigation, the potential availability of tax assets in the future and
related matters, and the sufficiency of our capital resources, all of which are
based on current expectations, estimates, and forecasts, and the beliefs and
assumptions of our management. Words such as “expect,” “anticipate,” “project,”
“intend,” “plan,” “estimate,” variations of such words, and similar expressions
also are intended to identify such forward-looking statements. These
forward-looking statements are subject to risks, uncertainties, and assumptions
that are difficult to predict. Therefore, actual results may differ materially
and adversely from those expressed in any forward-looking statements. Readers
are directed to risks and uncertainties identified under Part II, Item 1A, “Risk
Factors,” 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.





The
following discussion is designed to provide a better understanding of our
unaudited financial statements, including a brief discussion of our business and
products, key factors that impacted our performance, and a summary of our
operating results. The following discussion should be read in conjunction with
the unaudited financial statements and the notes thereto included in Part I,
Item 1 of this Quarterly Report on Form 10-Q, and the consolidated financial
statements and notes thereto and Management’s Discussion and Analysis of
Financial Condition and Results of Operations contained in our Annual Report on
Form 10-K for the year ended December 31, 2009. Historical results and
percentage relationships among any amounts in the financial statements are not
necessarily indicative of trends in operating results for any future
periods.





Overview





We
develop and market software products and services targeted to small businesses
that are delivered via a SaaS model. We also provide website consulting
services, primarily in the e-commerce retail industry. We reach small businesses
primarily through arrangements with channel partners that private label our
software applications and market them to their customer bases through their
corporate websites. We believe these relationships provide a cost- and
time-efficient way to market to a diverse and fragmented yet very sizeable
small-business sector. We also offer our products directly to end-user small
businesses through our OneBiz ® branded
website.





In the
second half of 2007, we commenced an overall evaluation of our business model as
well as our current technologies, the outcome of which was our decision to
develop a core industry-standard platform for small business with an
architecture designed to integrate with a virtually unlimited number of other
applications, services, and existing infrastructures. These applications would
include not only our own small-business applications, which we are currently
optimizing, but also other applications we expect to arise from collaborative
partnerships with third-party developers and service providers. In addition, we
identified emerging-market opportunities in the small-business segment to
leverage social networking and community building. We are currently refining and
integrating these capabilities into the core platform to be readily available in
a “plug-and-play” fashion to meet any anticipated customer need or desire. On
July 14, 2009, we announced the release of OneBiz 1.1, a suite of web-based
business management tools designed for small business owners to operate and grow
their businesses. We believe that this platform and associated applications will
provide opportunities for new sources of revenue, including an increase in our
subscription fees. We also believe, because the platform is designed to follow
industry-standard protocol, that the customization efforts and associated
timeline previously necessary to meet a particular customer’s requirements will
diminish significantly, allowing us to shorten the sale-to-revenue cycle.  As
we neared completion of the development of our industry-standard platform, we
began shifting our focus from development toward the sales and marketing of the
new platform in the fourth quarter of 2008 and continued the effort throughout
2010.





Sources
of Revenue





We derive
revenues from the following sources:





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




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




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




·
            Hosting
      fees – fees charged for providing network accessibility  for our
      customers  using our customized
  platforms





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




18




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





Subscription
fees primarily consist of sales of subscriptions through private-label marketing
partners to end users. We typically have a revenue-share arrangement with these
private-label marketing partners in order to encourage them to market our
products and services to their customers. We make subscription sales either on a
subscription or on a “for fee” basis. Applications for which subscriptions are
available vary from our own direct sale website, OneBiz ®, to the
websites of our partners. Subscriptions are generally payable on a monthly basis
and are typically paid via credit card of the individual end user. We are
focusing our efforts on enlisting new channel partners as well as diversifying
with vertical intermediaries in various industries.  In the past, we
recognized all subscription revenue on a gross basis and in accordance with our
policy to periodically review our accounting policies we recognized that certain
contracts require the reporting of subscription revenue on a gross basis and
others on a net basis according to US GAAP.  On that basis, we
continue to report subscription revenue from certain contracts on a gross basis
and others on a net basis.  The net effect of this reclassification of
expenses only impacts gross revenue and certain gross expenses; it does not
change the net income.  We discuss this matter in more depth in
Footnote 1 to the financial statements.





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





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





Hosting
fees are charged for providing our customers with network
accessibility.





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




19





Cost
of Revenues





Cost of
revenues primarily is composed of costs related to third-party hosting services,
salaries and associated costs of customer support and professional services
personnel, credit card processing, depreciation of computer hardware and
software used in revenue-producing activities, domain name and e-mail
registrations, and allocated development expenses and general and administrative
overhead.





We
allocate development expenses to cost of revenues based on time spent by
development personnel on revenue-producing customer projects and support
activities. We allocate general and administrative overhead such as rent and
occupancy expenses, depreciation, general office expenses, and insurance to all
departments based on headcount. As such, general and administrative overhead
expenses are reflected in cost of revenues and each operating expense
category.





Operating
Expenses





In
previous years, we primarily focused our efforts on basic product development
and integration. In the early part of 2007, we also began to focus on licensing
our platform products and applications. During 2008, our primary business
initiatives included increasing subscription fee revenue and professional
services revenue, making organizational improvements, concentrating our
development efforts on enhancements and customization of our platforms and
applications, and shifting our strategic focus to the sales and marketing of our
products. In 2009, we launched our new industry-standard platform, OneBiz, along
with enhanced applications targeted to small businesses and devoted significant
resources to the sale and marketing of these applications through both channel
partners and direct sales efforts.





General and Administrative –
General and administrative expenses are composed primarily of costs associated
with our executive, finance and accounting, legal, human resources, and
information technology personnel and consist of salaries and related
compensation costs; professional services (such as outside legal counsel fees,
audit, and other compliance costs); depreciation and amortization; facilities
and insurance costs; and travel and other costs. We anticipate general and
administrative expenses will decrease in 2010 as the legal expenses and other
professional fees we incurred in 2009 will be reduced due to the tentative
settlements recently reached in certain legal matters.




20




Sales and Marketing – Sales
and marketing expenses are composed primarily of costs associated with our sales
and marketing activities and consist of salaries and related compensation costs
of our sales and marketing personnel, travel and other costs, and marketing and
advertising expenses. In the past, sales and marketing expenses also included
the amounts we paid to our marketing partners as part of the subscription
revenue received; in the past, the subscription revenue was presented as a gross
amount as was the amount included in the sales and marketing
category.  As part of our ongoing review of accounting pronouncements,
we have reclassified the revenues and sales and marketing expenses to reflect
net revenue and expense – see footnote 1 to the financial statements for further
details.  Historically, we spent limited funds on marketing,
advertising, and public relations, particularly due to our business model of
partnering with established companies with extensive small-business customer
bases. In June 2008, we engaged a public relations firm and, as a result, our
public relations expenses increased during the latter part of 2008 and 2009. As
we continue to execute our sales and marketing strategy to take our enhanced
products to market, we expect associated costs to increase in 2010 due to
targeting new partnerships, development of channel partner enablement programs,
advertising campaigns, additional sales and marketing personnel, and the various
percentages of revenues we may be required to pay to future partners as
marketing fees.





Research and Development –
Research and development expenses include costs associated with the development
of new products, enhancements of existing products, and general technology
research. These costs are composed primarily of salaries and related
compensation costs of our research and development personnel as well as outside
consultant costs.





Professional
accounting standards require capitalization of certain software development
costs subsequent to the establishment of technological feasibility, with costs
incurred prior to this time expensed as research and development. Technological
feasibility is established when all planning, designing, coding, and testing
activities that are necessary to establish that the product can be produced to
meet its design specifications have been completed. Historically, we had not
developed detailed design plans for our SaaS applications, and the costs
incurred between the completion of a working model of these applications and the
point at which the products were ready for general release had been
insignificant. As a result of these factors, combined with the historically low
revenue generated by the sale of the applications that do not support the net
realizable value of any capitalized costs, we continued the expensing of
underlying costs as research and development.





Beginning
in May 2008, we determined that it was strategically desirable to develop an
industry-standard platform and to enhance our current SaaS applications. A
detailed design plan indicated that the product was technologically feasible. In
July 2008, we commenced development, and from that point in time, we have been
capitalizing all related costs in accordance with accounting
principles. Because of our scalable and secure multi-user architecture, we
are able to provide all customers with a service based on a single version of
our application. As a result, we do not have to maintain multiple versions,
which enables us to incur relatively low development costs as compared to
traditional enterprise software business models. We completed the core
development of our new applications during 2009 and we expect that future
research and development expenses will decrease in both absolute and relative
dollars as we amortize the capitalized costs associated with the new platform
and reduce our personnel to a core group focused on enhancements and custom
development work for customers.





Stock-Based Expenses – Our
operating expenses include stock-based expenses related to options, restricted
stock awards, and warrants issued to employees and non-employees. These charges
have been significant and are reflected in our historical financial results.
Effective January 1, 2006, we adopted accounting standards that resulted and
will continue to result in material costs on a prospective basis as long as a
significant number of options are outstanding. In June 2007, we limited the
issuance of awards under our 2004 Equity Compensation Plan, or the 2004 Plan, to
awards of restricted or unrestricted stock. In June 2008, we made options
available for grant under the 2004 Plan once again, primarily due to the adverse
 tax
consequences to recipients of restricted stock upon the lapsing of
restrictions.





Critical
Accounting Policies and Estimates





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




21




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





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





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





1.     persuasive
evidence of an arrangement exists





2.     delivery
has occurred





3.     the
fee is fixed or determinable





4.     collectability
is probable





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





We
account for consulting, website design fees and application development services
separately from the license of associated software platforms when these services
have value to the customer and there is objective and reliable evidence of fair
value of each deliverable. When accounted for separately, we recognize revenue
as the services are rendered for time and material contracts, and when
milestones are achieved and accepted by the customer for fixed price or
long-term contracts. The majority of our consulting service contracts are on a
time and material basis, and we typically bill our customers monthly based upon
standard professional service rates.





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




22





Subscription
fees primarily consist of sales of subscriptions through private-label marketing
partners to end users. We typically have a revenue-share arrangement with these
marketing partners in order to encourage them to market our products and
services to their customers. Subscriptions are generally payable on a monthly
basis and are typically paid via credit card of the individual end user. We
accrue any payments received in advance of the subscription period as deferred
revenue and amortize them over the subscription period. In the past, we
recognized all subscription revenue on a gross basis and in accordance with our
policy to periodically review our accounting policies we determined that certain
contracts require the reporting of subscription revenue on a gross basis and
others on a net basis according to US GAAP.  On that basis, we
continue to report subscription revenue from certain contracts on a gross basis
and others on a net basis.  The net effect of this reclassification of
expenses only impacts gross revenue and certain gross expenses; it does not
change the net income.


Because
our customers generally do not have the contractual right to take possession of
the software we license or market at any time, we recognize revenue on hosting
and maintenance fees as we provide the services in accordance with US
GAAP.





Provision for Doubtful Accounts
– We maintain an allowance for doubtful accounts for estimated losses
resulting from the inability, failure, or refusal of our customers to make
required payments. We evaluate the need for an allowance for doubtful accounts
based on specifically identified amounts that we believe to be potentially
uncollectible. Although we believe that, our allowances are adequate, if the
financial conditions of our customers deteriorate, resulting in an impairment of
their ability to make payments, or if we underestimate the allowances required,
additional allowances may be necessary, which will result in increased expense
in the period in which such determination is made.





Impairment of Long-Lived
Assets – We record our long-lived assets, such as intangibles, property
and equipment, at cost. We review the carrying value of our indefinite lived
intangibles for possible impairment at least annually in the fourth quarter, and
all long-lived assets whenever events or changes in circumstances indicate that
the carrying amount of assets may not be recoverable in accordance with the US
GAAP. We measure the recoverability of assets to be held and used by comparing
the carrying amount of the asset to the fair value. If we consider such assets
to be impaired, we measure the impairment as the amount by which the carrying
amount exceeds the fair value, and we recognize it as an operating expense in
the period in which the determination is made. We report assets to be disposed
at the lower of the carrying amount or fair value less costs to sell. Although
we believe that the carrying values of our long-lived assets are appropriately
stated, changes in strategy or market conditions or significant technological
developments could significantly impact these judgments and require adjustments
to recorded asset balances.





In
addition to the recoverability assessment, we also routinely review the
remaining estimated useful lives of our long-lived assets. Any reduction in the
useful-life assumption will result in increased depreciation and amortization
expense in the period when such determinations are made, as well as in
subsequent periods.





Income Taxes – We are
required to estimate our income taxes in each of the jurisdictions in which we
operate. This involves estimating our current tax liabilities in each
jurisdiction, including the impact, if any, of additional taxes resulting from
tax examinations, as well as making judgments regarding our ability to realize
our deferred tax assets. Such judgments can involve complex issues and may
require an extended period to resolve. In the event we determine that we will
not be able to realize all or part of our net deferred tax assets, we would make
an adjustment in the period we make such determination. We recorded no income
tax expense in 2009 and 2008, as we have experienced significant operating
losses to date. If utilized, we may apply the benefit of our total net operating
loss carryforwards to reduce future tax expense. Since our utilization of these
deferred tax assets is dependent on future profits, which are not assured, we
have recorded a valuation allowance equal to the net deferred tax assets. These
carryforwards would also be subject to limitations, as prescribed by applicable
tax laws. As a result of prior equity financings and the equity issued in
conjunction with certain acquisitions, we have incurred ownership changes, as
defined by applicable tax laws. Accordingly, our use of the acquired net
operating loss carryforwards may be limited. Further, to the extent that any
single-year loss is not utilized to the full amount of the limitation, such
unused loss is carried over to subsequent years until the earlier of its
utilization or the expiration of the relevant carryforward period.




Results
of Operations for the Three Months Ended March 31, 2010 and March 31,
2009





The
following table sets forth certain statements of operations data for the periods
indicated:





Three Months Ended
              March 31, 2010
            
            
            Three Months Ended
              March 31, 2009Dollars
            
            
            % of
              Revenue
            
            
            Dollars
            
            
            % of
              RevenueTotal
      revenues
            
            $
            363,900
            
            
            
            100.0
            %
            
            $
            481,687
            
            
            
            100.0
            %Cost
      of revenues
            
            
            365,934
            
            
            
            100.5
            %
            
            
            492,601
            
            
            
            102.3
            %Gross
      profit
            
            $
            (2,034
            )
            
            
            -.5
            %
            
            $
            (10,914
            )
            
            
            -2.3
            %Operating
      expenses
            
            
            857,059
            
            
            
            235.5
            %
            
            
            1,472,008
            
            
            
            305.6
            %Loss
      from operations
            
            $
            (859,093
            )
            
            
            -236.0
            %
            
            $
            (1,482,922
            )
            
            
            -307.9
            %Other
      income (expense), net
            
            
            (57,832
            )
            
            
            -15.9
            %
            
            
            (111,731
            )
            
            
            -23.2
            %Net
      loss
            
            $
            (916,925
            )
            
            
            -251.9
            %
            
            $
            (1,594,653
            )
            
            
            -331.1
            %Net
      loss per common share
            
            $
            (0.05
            )
            
            
            
            
            
            $
            (0.09
            )





23




Revenues





Revenues
for the three months ended March 31, 2010 and 2009 comprise the
following:





Three Months Ended
              March 31,
            
            
            Change2010
            
            
            2009
            
            
            Dollars
            
            
            PercentSubscription
      fees
            
            $
            136,258
            
            
            $
            241,782
            
            
            $
            (105,524
            )
            
            
            -44
            %Professional
      service fees
            
            
            62,775
            
            
            
            118,773
            
            
            
            (55,998
            )
            
            
            -47
            %License
      fees
            
            
            87,800
            
            
            
            11,250
            
            
            
            76,550
            
            
            
            680
            %Hosting
      fees
            
            
            44,272
            
            
            
            72,211
            
            
            
            (27,939
            )
            
            
            -39
            %Other
      revenue
            
            
            32,795
            
            
            
            37,671
            
            
            
            (4,876
            )
            
            
            -13
            %Total
      revenues
            
            $
            363,900
            
            
            $
            481,687
            
            
            $
            (117,787
            )
            
            
            -24
            %





Revenues
decreased 24% to $364,000 for the three months ended March 31, 2010 from
$482,000 for the same period in 2009. Our overall decrease in revenues was
driven by substantial declines in subscription fees, professional service fees,
and hosting fees. Select items are discussed in detail below.





Subscription
Fees





Revenues
from subscription fees for the three months ended March 31, 2010 and 2009 are as
follows:





Three Months Ended
              March 31,
            
            Change2010
            
            
            2009
            
            Dollars
            
            
            PercentSubscription fees
            
            $
            136,258
            
            
            $
            241,782
            
            
            $
            (105,524
            )
            
            
            -44
            %Percent
      of total revenues
            
            
            37.4
            %
            
            
            50.2
            %





Revenues
from subscription fees decreased 44% to $136,000 for the three months ended
March 31, 2010 from $242,000 for the same period in 2009. This decline is
primarily attributable to the ongoing migration of one direct-selling
organization customer to its own technology solution that has resulted in a
continuous decline in subscription fees.





Professional
Service Fees





Revenues
from professional service fees for the three months ended March 31, 2010 and
2009are as follows:





Three Months Ended
              March 31,
            
            Change2010
            
            
            2009
            
            Dollars
            
            
            PercentProfessional service
      fees
            
            $
            62,775
            
            
            
            118,773
            
            
            
            (55,998
            )
            
            
            -47
            %Percent
      of total revenues
            
            
            19.5
            %
            
            
            24.7
            %





Revenues
from professional service fees decreased 47% to $63,000 for the three months
ended March 31, 2010 from $119,000 for the same period in 2009. This decrease is
primarily due to a significant decline in web consulting services provided to
customers during the first quarter of 2010.




24


License
Fees





Revenues
from license fees for the three months ended March 31, 2010 and 2009 are as
follows:





Three Months Ended
              March 31,
            
            Change2010
            
            
            2009
            
            Dollars
            
            
            PercentLicense fees
            
            $
            87,800
            
            
            
            11,250
            
            
            
            76,550
            
            
            
            680
            %Percent
      of total revenues
            
            
            24.1
            %
            
            
            2.3
            %





Revenues
from license fees increased 680% to $88,000 for the three months ended March 31,
2010 from $11,000 for the same period in 2009. License fee revenue recognized in
the first quarter of 2010 comprised the ratable recognition of a term license
that commenced in December 2009. License fee revenue recognized in the first
quarter of 2009 comprised three installments of a license agreement to a single
customer.





Hosting
Fees





Revenues
from hosting fees for the three months ended March 31, 2010 and 2009are as
follows:





Three
      Months Ended
              March
      31,
            
            Change2010
            
            
            2009
            
            Dollars
            
            
            PercentHosting
      fees
            
            $
            44,272
            
            
            
            72,211
            
            
            
            (27,939
            )
            
            
            -39
            %Percent
      of total revenues
            
            
            12.2
            %
            
            
            15.0
            %





Revenues
from hosting fees decreased 39% to $44,000 for the three months ended March 31,
2010 from $72,000 for the same period in 2009. This decrease is primarily due to
the loss of a major customer offset by the increase in fees from a customer who
went into live production in early 2010. We expect hosting fees to increase on
an overall basis as we add new channel partners and expand our base of
subscribing end users.





Other
Revenue





Revenues
from other sources for the three months ended March 31, 2010 and 2009 are as
follows:





Three Months Ended
              March 31,
            
            Change2010
            
            
            2009
            
            Dollars
            
            
            PercentOther
      revenue
            
            $
            32,795
            
            
            
            37,671
            
            
            
            (4,876
            )
            
            
            -13
            %Percent
      of total revenues
            
            
            9.0
            %
            
            
            7.8
            %





Revenues
from non-core activities decreased 13% to $33,000 for the three months ended
March 31, 2010 from $38,000 for the same period in 2009. This decrease is
primarily attributable to lower billed credit card and payment gateway fees
resulting from the loss of a major customer. We expect these revenue streams to
continue to be insignificant in the future as we focus on the growth of our
subscription fees revenue.





Cost
of Revenues





Cost of
revenues for the three months ended March 31, 2010 and 2009 are as
follows:




25





Three Months Ended
              March 31,
            
            Change2010
            
            
            2009
            
            Dollars
            
            
            PercentCost
      of revenues
            
            $
            365,934
            
            
            $
            492,601
            
            
            $
            (126,667
            )
            
            
            -26
            %Percent
      of total revenues
            
            
            100.5
            %
            
            
            102.3
            %





Cost of
revenues decreased 26% to $366,000 for the three months ended March 31, 2010
from $493,000 for the same period in 2009. This decrease is the result of lower
professional services costs associated with professional service fees revenue,
which is generally billed on a time and material basis. In addition, we have
allocated lower amounts of development and general and administrative expenses
as a result of an overall reduction in those areas.





Operating
Expenses





Operating
expenses for the three months ended March 31, 2010 and 2009 comprise the
following:





Three Months Ended
              March 31,
            
            
            Change2010
            
            
            2009
            
            
            Dollars
            
            
            PercentSales
      and marketing
            
            $
            152,635
            
            
            $
            299,539
            
            
            $
            (146,904
            )
            
            
            -49
            %Research
      and development
            
            
            32,005
            
            
            
            276,879
            
            
            
            (244,874
            )
            
            
            -88
            %General
      and administrative
            
            
            672,419
            
            
            
            895,590
            
            
            
            (223,171
            )
            
            
            -31
            %Total
      operating expenses
            
            $
            857,059
            
            
            $
            1,472,008
            
            
            $
            (614,949
            )
            
            
            -42
            %





Operating
expenses decreased 42% to $857,000 for the three months ended March 31, 2010
from $1,472,000 for the same period in 2009. This decrease is the direct result
of our concerted efforts during the latter part of 2009 and into 2010 to reduce
operating expenses by improving efficiencies and eliminating unnecessary costs.
Select items are discussed in detail below.





Sales
and Marketing





Sales and
marketing expenses for the three months ended March 31, 2010 and 2009 are as
follows:





Three Months Ended
              March 31,
            
            Change2010
            
            
            2009
            
            Dollars
            
            
            PercentSales
      and marketing
            
            $
            152,635
            
            
            $
            299,539
            
            
            $
            (146,904
            )
            
            
            -49
            %Percent
      of total revenues
            
            
            41.9
            %
            
            
            62.2
            %





Sales and
marketing expenses decreased 49% to $153,000 for the three months ended March
31, 2010 from $300,000 for the same period in 2009. This variance is primarily
attributable to reductions of $115,000 associated with staff reductions, $7,000
of business travel and marketing related costs and $24,000 in revenue sharing
expenses for one customer





Research
and Development





Research
and development expenses for the three months ended March 31, 2010 and 2009 are
as follows:




26





Three
      Months Ended
              March
      31,
            
            Change2010
            
            
            2009
            
            Dollars
            
            
            PercentResearch
      and development
            
            $
            32,005
            
            
            
            276,879
            
            
            
            (244,874
            )
            
            
            -88
            %Percent
      of total revenues
            
            
            8.8
            %
            
            
            57.5
            %





Research
and development expenses decreased 88% to $32,000 for the three months ended
March 31, 2010 from $277,000 for the same period in 2009. This decrease is
primarily attributable to $223,000 reduction in employee wages and related costs
due to staff reductions and a $22,000 reduction of outside contractor fees
incurred during the first quarter of 2010.





General
and Administrative





General
and administrative expenses for the three months ended March 31, 2010 and 2009
are as follows:





Three
      Months Ended
              March
      31,
            
            Change2010
            
            
            2009
            
            Dollars
            
            
            PercentGeneral
      and administrative
            
            $
            672,419
            
            
            
            895,590
            
            
            
            (223,171
            )
            
            
            -25
            %Percent
      of total revenues
            
            
            184.8
            %
            
            
            185.9
            %





General
and administrative expenses decreased 25% to $672,000 for the three months ended
March 31, 2010 from $896,000 for the same period in 2009. This decrease is
primarily attributable to reductions of $126,000 in personnel costs due to lower
headcount; $144,000 in depreciation and amortization related expenses as a
result of prior period impairment of intangible asset values,  $23,000
in specialized accounting and tax service expenses, $ 7,000 of insurance and
utilities, offset by an increase of $75,000 of additional legal expense due to
the ongoing Class Action case and the Nouri Matters.





Other
Income (Expense)





Other
income (expense) for the three months ended March 31, 2010 and 2009 comprise the
following:





Three
      Months Ended
              March
      31,
            
            
            Change2010
            
            
            2009
            
            
            Dollars
            
            
            PercentInterest
      expense, net
            
            $
            (210,695
            )
            
            $
            (127,998
            )
            
            $
            (82,697
            )
            
            
            -65
            %Gain
      on disposal of assets, net
            
            
            -
            
            
            
            10,267
            
            
            
            (10,267
            )
            
            
            -100
            %Gain
      on legal settlements, net
            
            
            152,863
            
            
            
            6,000
            
            
            
            146,863
            
            
            
            2,448
            %Other
      expense
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            %Total
      other expense
            
            $
            (57,832
            )
            
            $
            (111,731
            )
            
            $
            53,889
            
            
            
            -48
            %





Net other
expense decreased 48% to $58,000 for the three months ended March 31, 2010 from
$112,000 for the same period in 2009. This net decrease was primarily
attributable to an increase in the gain on legal settlements, which is discussed
in detail below.





Interest
Expense, Net





Interest
expense, net of interest income, for the three months ended March 31, 2010 and
2009 is as follows:





Three
      Months Ended
              March
      31,
            
            Change2010
            
            
            2009
            
            Dollars
            
            
            PercentInterest
      expense, net
            
            $
            (210,695
            )
            
            $
            (127,998
            )
            
            $
            (82,697
            )
            
            
            -65
            %Percent
      of total revenues
            
            
            57.9
            %
            
            
            26.6
            %





Net
interest expense increased 65% to $211,000 for the three months ended March 31,
2010 from $128,000 for the same period in 2009. This increase is primarily
attributable to additional draw of amounts from the bondholders throughout 2009
and continuing into 2010.





Interest
Expense, Net





Interest
expense, net of interest income, for the three months ended March 31, 2010 and
2009 is as follows:




27




Three
      Months Ended
              March
      31,
            
            Change2010
            
            
            2009
            
            Dollars
            
            
            PercentGain
      on legal settlements, net
            
            
            152,863
            
            
            
            6,000
            
            
            
            146,863
            
            
            
            2,448
            %Percent
      of total revenues
            
            
            42.0
            %
            
            
            1.2
            %





Gain on
legal settlements increased 2,448% to $153,000 for the three months ended March
31, 2010 from $6,000 for the same period in 2009. This increase is primarily
attributable to negotiations and settlement of outstanding legal fees associated
with the ongoing litigation issues.





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
first quarter of 2010 primarily due to continued substantial uncertainty based
on objective evidence regarding our ability to realize our deferred tax assets,
thereby warranting a full valuation allowance in our financial statements. We
have approximately $48.2 million in net operating loss carryforwards, which may
be utilized to offset future taxable income.





Utilization
of our net operating loss carryforwards may be subject to substantial annual
limitation due to the ownership change limitations provided by the Internal
Revenue Code of 1986, as amended, and similar state provisions. Such an annual
limitation could result in the expiration of the net operating loss
carryforwards before utilization.





Liquidity
and Capital Resources





Overview





We
require cash to fund our operating expenses and working capital requirements,
including outlays for capital expenditures and debt service. As of March 31,
2010, our principal sources of liquidity were cash and cash equivalents totaling
$22,000 and current accounts receivable of $511,593, which is fully reserved, as
compared to $120,000 of cash and cash equivalents and $13,000 in accounts
receivable as of December 31, 2009. We maintain a low cash balance because of
automated sweeps among our accounts at Paragon whereby all available cash at the
end of each day is used to pay down our line of credit with Paragon, the purpose
of which is to reduce our interest expense. As of March 31, 2010, we had drawn
approximately $2,100,000 on the $2,470,000 line of credit, leaving approximately
$377,000 available under the line of credit for our operations. Deferred revenue
at March 31, 2010 was $39,000 as compared to $46,000 at December 31,
2009.





As of May
11, 2010, our principal sources of liquidity were cash and cash equivalents
totaling approximately $441,000 and $512,000 of accounts receivable, which is
fully reserved.. In addition, we had drawn approximately $2,007,000 on the
Paragon line of credit, leaving approximately $463,000 available under the line
of credit for operations. As of May 11, 2010, we also have a commitment from our
convertible secured subordinated noteholders to purchase up to an additional
$4.65 million in Notes upon approval and call by our Board of
Directors.





Cash
Flows





During
the three months ended March 31, 2010, our working capital deficit increased by
approximately $300,000 to $6,916,893 from a working capital deficit of
$6,575,351 at December 31, 2009. As described more fully below, the working
capital deficit at March 31, 2010 is primarily attributable to negative cash
flows from operations, offset in part by net debt borrowings.




28


Cash
Flows from Operating Activities





Three
      Months Ended
              March
      31,
            
            
            Change2010
            
            
            2009
            
            
            Dollars
            
            
            PercentNet
      cash used in operating activities
            
            $
            791,194
            
            
            $
            884,892
            
            
            $
            (93,698
            )
            
            
            -11
            %





Net cash
used in operating activities decreased 11% to $791,000 for the three months
ended March 31, 2010 from $885,000 for the same period in 2009. This decrease is
primarily attributable to a lower net loss for the period, a decrease in
accounts receivable, and an increase in accrued liabilities, offset in part by
an increase in prepaid expenses and decreases in accounts payable and deferred
revenue.





Cash
Flows from Investing Activities





Three
      Months Ended
              March
      31,
            
            
            Change2010
            
            
            2009
            
            
            Dollars
            
            
            PercentNet
      cash provided by (used in) investing activities
            
            $
            16,438
            
            
            $
            (83,281
            )
            
            $
            99,719
            
            
            
            120
            %





Net cash
provided by investing activities increased 120% to $16,000 for the three months
ended March 31, 2010 from net cash used in investing activities of $83,000 for
the same period in 2009. This net cash provided is attributable to the
amortization of capitalized software costs related to our new industry-standard
platform offset by the purchase of $835 of equipment compared to the $128,000 of
investment in capitalized software and equipment for the same period in 2009
offset, in part, by proceeds from the sale of equipment to a
customer.





Cash
Flows from Financing Activities





Three
      Months Ended
              March
      31,
            
            
            Change2010
            
            
            2009
            
            
            Dollars
            
            
            PercentNet
      cash provided by (used in) financing activities
            
            $
            677,437
            
            
            $
            987,860
            
            
            $
            310,423
            
            
            
            31
            %





Net cash
provided by financing activities decreased 31% to $677,000 for the three months
ended March 31, 2010 from net cash provided by financing activities of $988,000
for the same period in 2009. This net source of cash is primarily due to net
increase in debt borrowings in the first quarter of 2010.





The net
cash for the first quarter of 2010 from our financing activities was generated
through debt financing, as described below.





Debt
Financing.





Revolving
Credit Facility





On
February 20, 2008, the Company entered into a new revolving credit arrangement
with Paragon and delivered to Paragon the Paragon Note.  The Paragon
Note was renewed as of February 22, 2010, pursuant to the Modification Agreement
between Paragon and the Company, which extended the maturity date from February
11, 2010 to August11, 2010 and changed the interest rate on the Paragon Note
from a variable annual rate equal to The Wall Street Journal Prime Rate, with a
floor of 5.50%, to a fixed annual rate of 6.50%.  The total line of
credit advanced by Paragon remains $2.5 million and can be used for general
working capital.  The line of credit is secured by an irrevocable
standby letter of credit in the amount of $2.5 million issued by HSBC with Atlas
as account party, with an expiration date of September 17, 2010, which was
extended from the prior expiration date of February 18, 2010.




As an
incentive for the letter of credit from Atlas to secure the Wachovia line of
credit, we had entered into a stock purchase warrant and agreement with Atlas.
Under the terms of the agreement, Atlas received a warrant to purchase up to
444,444 shares of our common stock at $2.70 per share within 30 business days of
the termination of the Wachovia line of credit or if we are in default under the
terms of the line of credit with Wachovia. In consideration for Atlas providing
the letter of credit to Paragon, we agreed to amend the agreement to provide
that the warrant is exercisable within 30 business days of the termination of
the Paragon line of credit or if we are in default under the terms of the line
of credit with Paragon.




Furthermore,
in connection with establishing the Paragon line of credit, Atlas and the
Company entered into a Reimbursement Agreement, dated November 14, 2006 (as
amended, the “Reimbursement Agreement”) to provide that, in the event of a
default by the Company in the repayment of the Paragon Note that results in the
letter of credit being drawn, the Company will reimburse Atlas any sums that
Atlas is required to pay under the letter of credit in either cash or stock, at
the Company’s election.  On January 19, 2010, Atlas and the Company
entered into the Second Amendment to the Reimbursement Agreement (the “Second
Amendment”) to provide that at the sole discretion of Atlas, any such payments
to Atlas may be made in cash, common stock of the Company, or convertible
reimbursement notes.




The
Company entered into the Second Amendment in partial consideration for a waiver
from Atlas as the Requisite Percentage Holder. Sales of Notes to the convertible
noteholders are subject to certain conditions, including the absence of events
or conditions that could reasonably be expected to have a material adverse
effect on the ability of the Company to perform its obligations under the Note
Purchase Agreement. The agent for the convertible noteholders had advised the
Company that the Company’s obligations to the Nouris may constitute such a
material adverse effect. However, Atlas, as the Requisite Percentage Holder,
advised the Company that it would be willing to waive the foregoing funding
conditions relating to the judgment if, and for so long as, the Nouris do
not actively pursue enforcement of such judgment, and, in addition, if the
Company entered into the Second Amendment.




29




Convertible
Notes





On
November 14, 2007, in an initial closing, the Company sold $3.3 million
aggregate principal amount of Notes (the “Initial Notes”). In addition, the
noteholders committed to purchase on a pro rata basis up to $5.2 million
aggregate principal of Notes in future closings upon approval and call by our
Board of Directors. On August 12, 2008, we exercised our option to sell $1.5
million aggregate principal of additional Notes (the “Additional Notes”) to
existing noteholders, with substantially the same terms and conditions as the
Initial Notes. In connection with the sale of the Additional Notes, the
noteholders holding a majority of the aggregate principal amount of the Notes
then outstanding agreed to increase the aggregate principal amount of Notes that
they are committed to purchase from $8.5 million to $15.3 million. On November
21, 2008, we sold $500,000 aggregate principal amount of additional Notes due
November 14, 2010, to two new convertible noteholders, with substantially the
same terms and conditions as the Initial Notes and the Additional Notes. At
December 31, 2008, $5.3 million aggregate principal amount of Notes were
outstanding.




On
January 6, 2009, the Company sold $500,000 aggregate principal amount of Notes
to Atlas, on substantially the same terms and conditions as the previously
issued Notes.




On February 24, 2009, the Company sold
$500,000 aggregate principal amount of Notes to Atlas on substantially the same
terms and conditions as the previously issued Notes. On the same date, the
noteholders holding a majority of the aggregate principal amount of the Notes
outstanding agreed that the Company may sell up to $6 million aggregate
principal amount of Additional Notes to new convertible noteholders or existing
noteholders at any time on or before December 31, 2009 with a maturity date of
November 14, 2010 or later. In addition, the maturity date definition for each
of the Notes was changed from November 14, 2010 to the date upon which the note
is due and payable, which is the earlier of (1) November 14, 2010, (2) a change
of control, or (3) if an event of default occurs, the date upon which
noteholders accelerate the indebtedness evidenced by the Notes. The formula for
calculating the conversion price of the Notes was also amended such that the
conversion price of each outstanding note and any additional note sold in the
future would be the same and set at the lowest applicable conversion price, as
described below.




On each
of April 3, 2009 and June 2, 2009, the Company sold a Note in the principal
amount of $500,000 to Atlas on substantially the same terms and conditions as
the previously issued Notes.  On each of July 16, 2009, August 26,
2009, September 8, 2009, and October 5, 2009, the Company sold a Note in the
principal amount of $250,000 to Atlas on substantially the same terms and
conditions as the previously issued Notes.  On October 9, 2009, the
Company sold a Note in the principal amount of $250,000 to UBP, Union Bancaire
Privee, an existing noteholder, on substantially the same terms and conditions
as the previously issued Notes.  On November 6, 2009, the Company sold
a Note to Atlas in the principal amount of $500,000, on December 23, 2009 the
Company sold a Note to Atlas in the principal amount of $750,000, and on
February 11, 2010, the Company sold a Note to Atlas in the principal amount of
$500,000, all upon substantially the same terms and conditions as the previously
issued Notes




On March
5, 2010, the Company and the Requisite Percentage Holder, among other
convertible noteholders, entered into the Fourth Amendment.  The
Fourth Amendment extends the original maturity date of the Notes from November
14, 2010 to November 14, 2013, and amends the Note Purchase Agreement and the
Registration Rights Agreement, dated November 14, 2007, to reflect this
extension, as reported on the Form 8-K filed by the Company on March 10,
2010.




On April
1, 2010, the Company sold a Note to Atlas in the principal amount of $350,000,
due November 14, 2013, upon substantially the same terms and conditions as
the previously issued Notes.





On the
earlier of the maturity date of November 14, 2013 or a merger or acquisition or
other transaction pursuant to which our existing stockholders hold less than 50%
of the surviving entity, or the sale of all or substantially all of our assets,
or similar transaction, or event of default, each noteholder in its sole
discretion shall have the option to:





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





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





If a
noteholder elects to convert its Notes under these circumstances, the conversion
price will be the lowest “applicable conversion price” determined for each Note.
The “applicable conversion price” for each Note shall be calculated by
multiplying 120% by the lowest of




·
            the
      average of the high and low prices of the Company’s common stock on the
      OTC Bulletin Board averaged over the five trading days prior to the
      closing date of the issuance of such
Note,




·
            if
      the Company’s common stock is not traded on the Over-The-Counter market,
      the closing price of the common stock reported on the Nasdaq National
      Market or the principal exchange on which the common stock is listed,
      averaged over the five trading days prior to the closing date of the
      issuance of such Note, or




·
            the
      closing price of the Company’s common stock on the OTC Bulletin Board, the
      Nasdaq National Market, or the principal exchange on which the common
      stock is listed, as applicable, on the trading day immediately preceding
      the date such Note is converted, in each case as adjusted for stock
      splits, dividends or combinations, recapitalizations, or similar
      events.




We are
obligated to pay interest on the notes at an annualized rate of 8% payable in
quarterly installments commencing three months after the purchase date of the
Notes. We are not permitted to prepay the Notes without approval of the holders
of at least a majority of the principal amount of the notes then
outstanding.





Payment
of the Notes will be automatically accelerated if we enter voluntary or
involuntary bankruptcy or insolvency proceedings.





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




30




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





No fees
are payable in connection with the offering of Notes.





We have
not yet achieved positive cash flows from operations, and our main sources of
funds for our operations are the sale of securities in private placements, the
sale of additional Notes, and bank lines of credit. We must continue to rely on
these sources until we are able to generate sufficient cash from revenues to
fund our operations. We believe that anticipated cash flows from operations,
funds available from our existing line of credit (which expires August 2010, as
described above), replacement of the existing line of credit and additional
issuances of notes, together with cash on hand, will provide sufficient funds to
finance our operations at least for the next 12 to 18 months, depending on our
ability to achieve strategic goals outlined in our annual operating budget
approved by our Board of Directors. Changes in our operating plans, lower than
anticipated sales, increased expenses, or other events may cause us to seek
additional equity or debt financing in future periods. There can be no guarantee
that financing will be available on acceptable terms or at all. Additional
equity financing could be dilutive to the holders of our common stock, and
additional debt financing, if available, could impose greater cash payment
obligations and more covenants and operating restrictions.  If the
tentative Class Action settlement is finalized, current shareholders will be
further diluted due to the issuance of an additional 1,475,000 shares of common
stock pursuant to the terms of the tentative agreement.


31




Going
Concern





Our
independent registered public accountants have issued an explanatory paragraph
in their report included in our Annual Report on Form 10-K for the year ended
December 31, 2009 in which they express substantial doubt as to our ability to
continue as a going concern. The financial statements do not include any
adjustments relating to the recoverability and classification of recorded asset
amounts or the amounts or classification of liabilities that might be necessary
should we be unable to continue as a going concern. Our continuation as a going
concern depends on our ability to generate sufficient cash flows to meet our
obligations on a timely basis, to obtain additional financing that is currently
required, and ultimately to attain profitable operations and positive cash
flows. There can be no assurance that our efforts to raise capital or increase
revenue will be successful. If our efforts are unsuccessful, we may have to
cease operations and liquidate our business.





Recent
Developments





On April
1, 2010, we sold $350,000 aggregate principal amount of Notes to Atlas with
substantially the same terms and conditions as the previously outstanding
Notes.





In 2008,
the Company entered into a non-cancellable sublease to relocate its North
Carolina headquarters to another facility near Research Triangle Park, under
which the Company prepaid rent in the total amount of $450,080 and purchased
existing furniture and fixtures for an additional $49,920, which furniture and
fixtures were capitalized for depreciation purposes.   Effective
May 1 , 2010, the sublease was restructured as a
direct lease with the owner of the property, with a termination date
of September 30, 2011 (the "Lease").  After taking into account the monthly
amortization of prepaid rent, the Company is obligated to make minimum
monthly rent payments in the amount of $4,208.13 during the term of the
Lease, together with a percentage of operating expenses.  The
Company includes the prepaid rent amount of $450,080 as an asset being
amortized monthly over the remaining term of the Lease.




Item
3.
                 
Quantitative and Qualitative
Disclosures About Market Risk




Not
applicable.





Item
4.                 Controls
and Procedures





Not
applicable.





Item
4T.               Controls
and Procedures





Our
management, with the participation of our interim Chief Executive Officer and
interim Chief Financial Officer, evaluated the effectiveness of our disclosure
controls and procedures as of March 31, 2010. The term “disclosure controls
and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the
Exchange Act, means controls and other procedures of a company that are designed
to ensure that information required to be disclosed by a company 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 a company in the reports that it files or submits under the
Exchange Act is accumulated and communicated to the company’s management,
including its principal executive and principal financial officers, as
appropriate to allow timely decisions regarding required disclosure. Management
recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, as ours are designed to do, and management necessarily applies its
judgment in evaluating the cost-benefit relationship of possible controls and
procedures. Based on the evaluation of our disclosure controls and procedures as
of March 31, 2010, our interim Chief Executive Officer and interim Chief
Financial Officer concluded that, as of such date, our disclosure controls and
procedures were not effective at the reasonable assurance level due to the
material weaknesses described below.





We
routinely review our internal control over financial reporting and from time to
time make changes intended to enhance the effectiveness of our internal control
over financial reporting.





Review of
our revenue recognition procedures during the fourth quarter of 2009 caused the
restatement of financial statements for the first three quarters of 2009 and
three quarters of 2008.  The restatement included the presentation
of  net subscription revenue as compared to the gross subscription
revenue.  In the past we recognized all subscription revenue on a
gross basis and in accordance with our policy to periodically review our
accounting procedures we identified the fact that certain contracts require
the reporting of subscription revenue on a gross basis and others on a net basis
according to US GAAP.  As a result of our review, we continue to
report subscription revenue from certain contracts on a gross basis and others
on a net basis.  The net effect of this reclassification of expenses
only impacts gross revenue and certain gross expenses; it does not change the
net income.





In order
to address the material weakness we have implemented a system whereby each new
contract entered into by the company must be reviewed and approved by the Chief
Financial Officer.





We will
continue to evaluate the effectiveness of our disclosure controls and procedures
and internal control over financial reporting on an ongoing basis and will take
action as appropriate. There have been no changes to our internal control over
financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act, during the three months ended March 31, 2010 that we
believe materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting.




32





PART
II – OTHER INFORMATION





Item
1.           Legal
Proceedings





Please
refer to Part I, Item 3 of our Annual Report on Form 10-K for the fiscal
year ended December 31, 2009 for a description of material legal
proceedings.





At this
time, except as discussed above, we are not able to determine the outcome of the
legal matters described above, nor can we estimate our entire potential
financial exposure. If an unfavorable resolution of any of these matters occurs,
our business, results of operations, and financial condition could be materially
adversely affected





Item
1A.        Risk Factors




We
operate in a dynamic and rapidly changing business environment that involves
substantial risk and uncertainty, and these risks may change over time. The
following discussion addresses some of the risks and uncertainties that could
cause, or contribute to causing, actual results to differ materially from
expectations. In evaluating our business, you should pay particular attention to
the descriptions of risks and uncertainties described below. If any of these
risks actually occur, our business, financial condition, or results of
operations could be materially and adversely affected.





Historically,
we have operated at a loss, and we continue to do so.





We have
had recurring losses from operations and continue to have negative cash flows.
If we do not become cash flow positive through additional financing or growth,
we may have to cease operations and liquidate our business. Our working capital,
which is dependent on our convertible note financing facility, should fund our
operations for the next 12 to 18 months. As of April 14, 2010, we have
approximately $405,000 available on our line of credit and approximately $4.65
million available through our convertible note 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 expenses on account of
lawsuits brought by a former officer and a former employee for advancement of
indemnification expenses and the tentative settlement of the shareholder class
action lawsuit (see Part II, Item I, Legal Proceedings,above)
will require us to seek additional funding sooner than we expect. If we fail to
raise sufficient financing, we will not be able to implement our business plan
and may not be able to sustain our business.





In
addition, our current primary credit facilities consisting of the Paragon line
of credit with a due date of August 14, 2010 and the convertible note financing
with a maturity date in November 2013. Should we be unable to repay the
principal then due from operations or from new or renegotiated capital funding
sources, we may not be able to sustain our business. As of April 14, 2010, we
have approximately $2.0 million outstanding on our line of credit and $10.45
million aggregate principal amount of convertible Notes outstanding, net of a
$200,000 reduction in connection with the Company’s sale/leaseback of equipment
in September 2009.








Our
independent registered public accountants indicate that they have substantial
doubts that we can continue as a going concern. Our independent registered
public accountants’ opinion may negatively affect our ability to raise
additional funds, among other things. If we fail to raise sufficient capital, we
will not be able to implement our business plan, we may have to liquidate our
business, and you may lose your investment.





Cherry,
Bekaert & Holland, L.L.P. our independent registered public accountants have
expressed substantial doubt in their report included with our Annual Report on
Form 10-K for the year ended December 31, 2009 about our ability to continue as
a going concern given our recurring losses from operations and deficiencies in
working capital and equity, which are described in the first risk factor above.
This opinion could materially limit our ability to raise additional funds by
issuing new debt or equity securities or otherwise. If we fail to raise
sufficient capital, we will not be able to implement our business plan, we may
have to liquidate our business, and you may lose your investment. You should
consider our independent registered public accountants’ comments when
determining if an investment in us is suitable.





33




Current
economic uncertainties in the global economy could adversely impact our growth,
results of operations, and our ability to forecast future business.





Since
2008 there has been a downturn in the global economy, slower economic activity,
decreased consumer confidence, reduced corporate profits and capital spending,
adverse business conditions, and liquidity concerns. These conditions make it
difficult for our customers and us to accurately forecast and plan future
business activities, and they could cause our customers to slow or defer
spending on our products and services, which would delay and lengthen sales
cycles, or change their willingness to enter into longer-term licensing and
support arrangements with us. Furthermore, during challenging economic times our
customers may face issues gaining timely access to sufficient credit, which
could result in an impairment of their ability to make timely payments to us. If
that were to occur, we may be required to increase our allowance for doubtful
accounts and our results would be negatively impacted.





We may
also face difficulties in obtaining additional credit or renewing existing
credit at favorable terms, or at all, which could impact our ability to fund our
operations or to meet debt repayment requirements as they come due.





We cannot
predict the timing, strength, or duration of any economic slowdown or subsequent
economic recovery. If the downturn in the general economy or markets in which we
operate persists or worsens from present levels, our business, financial
condition, and results of operations could be materially and adversely
affected.





Our
business is dependent upon the development and market acceptance of our
applications.




Our
future financial performance and revenue growth will depend, in part, upon the
successful development, integration, introduction, and customer acceptance of
our software applications. Thereafter, other new products, whether developed or
acquired, and enhanced versions of our existing applications will be critically
important to our business. Our business could be harmed if we fail to deliver
timely enhancements to our current and future solutions that our customers
desire. We also must continually modify and enhance our services and products to
keep pace with market demands regarding hardware and software platforms,
database technology, information security, and electronic commerce technical
standards. Our business could be harmed if we fail to achieve the improved
performance that customers want with respect to our current and future product
offerings. There can be no assurance that our products will achieve widespread
market penetration or that we will derive significant revenues from the sale or
licensing of our platforms or applications.





We
have not yet demonstrated that we have a successful business model.





We have
invested significantly in infrastructure, operations, and strategic
relationships to support our SaaS delivery model, which represents a significant
departure from the delivery strategies that we and other software vendors have
traditionally employed. To maintain positive margins for our small-business
services, our revenues will need to continue to grow more rapidly than the cost
of such revenues. We anticipate that our future financial performance and
revenue growth will depend, in large part, upon our Internet-based SaaS business
model and the results of our sales efforts to reach agreements with marketing
partners with small-business customer bases, but this business model may become
ineffective due to forces beyond our control that we do not currently
anticipate. Although we currently have various agreements and continue to enter
into new agreements, our success depends in part on the ultimate success of our
marketing 
partners and referral partners and their ability to market our products and
services successfully. Our partners are not obligated to provide potential
customers to us and may have difficulty retaining customers within certain
markets that we serve. In addition, some of these third parties have entered,
and may continue to enter, into strategic relationships with our competitors.
Further, many of our strategic partners have multiple strategic relationships,
and they may not regard us as significant for their businesses. Our strategic
partners may terminate their respective relationships with us, pursue other
partnerships or relationships, or attempt to develop or acquire products or
services that compete with our products or services. Our strategic partners also
may interfere with our ability to enter into other desirable strategic
relationships. If we are unable to maintain our existing strategic relationships
or enter into additional strategic relationships, we will have to devote
substantially more resources to the distribution, sales, and marketing of our
products and services.





34




In
addition, our end users currently do not sign long-term contracts. They have no
obligation to renew their subscriptions for our services after the expiration of
their initial subscription period and, in fact, they have often elected not to
do so. Our end users also may renew for a lower-priced edition of our services
or for fewer users. These factors make it difficult to accurately predict
customer renewal rates. Our customers’ renewal rates may decline or fluctuate as
a result of a number of factors, including when we begin charging for our
services, their dissatisfaction with our services, and their capability to
continue their operations and spending levels. If our customers do not renew
their subscriptions for our services or we are not able to increase the number
of subscribers, our revenue may decline and our business will
suffer.





Failure
to comply with the provisions of our debt financing arrangements could have a
material adverse effect on us.





Our
revolving line of credit from Paragon is secured by an irrevocable standby
letter of credit issued by HSBC with Atlas as account party. Our secured
subordinated convertible notes are secured by a first priority lien on all of
our unencumbered assets.





If an
event of default occurs under our debt financing arrangements and remains
uncured, then the lender could foreclose on the assets securing the debt. If
that were to occur, it would have a substantial adverse effect on our business.
In addition, making the principal and interest payments on these debt
arrangements may drain our financial resources or cause other material harm to
our business.





If
our security measures are breached and unauthorized access is obtained to our
customers’ data or our data, our service may be perceived as not being secure,
customers may curtail or stop using our service, and we may incur significant
legal and financial exposure and liabilities.





Our
service involves the storage and transmission of customers’ proprietary
information. If our security measures are breached as a result of third-party
action, employee error, malfeasance or otherwise and, as a result, unauthorized
access is obtained to our customers’ data or our data, our reputation could be
damaged, our business may suffer, and we could incur significant liability. In
addition, third parties may attempt to fraudulently induce employees or
customers to disclose sensitive information such as user names, passwords, or
other information in order to gain access to our customers’ data or our data,
which could result in significant legal and financial exposure and a loss of
confidence in the security of our service that would harm our future business
prospects. Because the techniques used to obtain unauthorized access, or to
sabotage systems, change frequently and generally are not recognized until
launched against a target, we may be unable to anticipate these techniques or to
implement adequate preventative measures. If an actual or perceived breach of
our security occurs, the market perception of the effectiveness of our security
measures could be harmed and we could lose sales and customers. In addition, our
new industry-standard platform may allow access by third-party technology
providers to access customer data. Because we do not control the transmissions
between our customers and third-party technology providers, or the processing of
such data by third-party technology providers, we cannot ensure the complete
integrity or security of such transmissions or processing.





The
SEC and criminal actions brought against certain former employees, and related
stockholder and other lawsuits have damaged our business, and they could damage
our business in the future.





The
SEC  lawsuit and criminal actions filed against a former officer and a
former employee, and the class action lawsuit filed against us and certain
current and former officers, directors, and employees have harmed our business
in many ways and may cause further harm in the future. Since the initiation of
these actions, our ability to raise financing from new investors on favorable
terms has suffered due to the lack of liquidity of our stock, the questions
raised by these actions, and the resulting drop in the price of our common
stock. As a result, we may not raise sufficient financing, if necessary, in the
future.





Legal and
other fees related to these actions have also reduced our available cash for
operations. We make no assurance that we will not continue to experience
additional harm as a result of these matters. The time spent by our management
team and directors dealing with issues related to these actions detracts, and
despite the tentative settlement of the Class Action continue to detract from
the time they spend on our operations, including strategy development and
implementation. These actions, more fully described in Part I, Item 3, “Legal
Proceedings“ in the Annual Report on Form 10-K for the year
ended  December 31, 2009, also have harmed our reputation in the
business community, jeopardized our relationships with vendors and customers,
and decreased our ability to attract qualified personnel, especially given the
media coverage of these events.




35




Compliance
with regulations governing public company corporate governance and reporting is
uncertain and expensive.





As a
public company, we have incurred and will continue to incur significant legal,
accounting, and other expenses that we did not incur as a private company. We
incur costs associated with our public company reporting requirements and with
corporate governance and disclosure requirements, including requirements under
the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, and rules implemented by the
SEC and the Financial Industry Regulatory Authority, or FINRA. We expect these
rules and regulations to increase our legal and financial compliance costs and
to make some activities more time consuming and costly.





We
currently are required to comply with the requirements of Section 404 of
Sarbanes-Oxley 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 year 2010. To comply
with these requirements, we are evaluating and testing our internal controls,
and where necessary, taking remedial actions, to allow management to report
on, and our independent auditors to attest to, our internal control over
financial reporting. As a result, we have incurred and will continue to incur
expenses and diversion of management’s time and attention from the daily
operations of the business, which may increase our operating expenses
and impair our ability to achieve profitability.





36




Officers,
directors, and principal stockholders control us. This might lead them to make
decisions that do not align with interests of minority
stockholders.





Our
principal stockholders beneficially own or control a large percentage of our
outstanding common stock. Certain of these principal stockholders hold warrants
and Notes, which may be exercised or converted into additional shares of our
common stock under certain conditions. The convertible noteholders have
designated a bond representative to act as their agent. We have agreed that the
bond representative shall be granted access to our facilities and personnel
during normal business hours, shall have the right to attend all meetings of our
Board of Directors and its committees, and shall receive all materials provided
to our Board of Directors or any committee of our Board. In addition, so long as
the notes are outstanding, we have agreed that we will not take certain material
corporate actions without approval of the bond representative.





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





Any
issuance of shares of our common stock in the future could have a dilutive
effect on the value of our existing stockholders’ shares.





We may
issue shares of our common stock in the future for a variety of reasons. For
example, under the terms of our stock purchase warrant and agreement with Atlas,
it may elect to purchase up to 444,444 shares of our common stock at $2.70 per
share upon termination of, or if we are in breach under the terms of, our line
of credit with Paragon. In connection with our private financing in February
2007, we issued warrants to the Investors (defined below) to purchase an
additional 1,176,471 shares of our common stock at $3.00 per share (which
warrants were not exercised and have expired in February 2010) and a warrant to
our placement agent in that transaction to purchase 35,000 shares of our common
stock at $2.55 per share. Upon maturity of their convertible Notes, our
convertible noteholders may elect to convert all, a part of, or none of their
Notes into shares of our common stock at a floating conversion price. In
addition, we may raise funds in the future by issuing additional shares of
common stock or other securities.





Under the
tentative Class Action settlement, the settlement consideration would include
1,475,000 shares of Company common stock. Under the terms of the tentative
settlement agreement, counsel for the settlement class may sell some or all of
the common stock received in the settlement before distribution to the class,
subject to the limitation that it cannot sell more than 10,000 shares on one day
or 50,000 shares in 30 calendar days. This issuance and sale may have a further
dilutive effect on the value of the Company’s outstanding shares.




If we
raise additional funds through the issuance of equity securities or debt
convertible into equity securities, the percentage of stock ownership by our
existing stockholders would be reduced. In addition, such securities could have
rights, preferences, and privileges senior to those of our current stockholders,
which could substantially decrease the value of our securities owned by them.
Depending on the share price we are able to obtain, we may have to sell a
significant number of shares in order to raise the necessary amount of capital.
Our stockholders may experience dilution in the value of their shares as a
result.





Shares
eligible for public sale could adversely affect our stock price.





Future
sales of substantial amounts of our shares in the public market, or the
appearance that a large number of our shares are available for sale, could
adversely affect market prices prevailing from time to time and could impair our
ability to raise capital through the sale of our securities. At April 8, 2010,
18,332,543 shares of our common stock were issued and outstanding, and a
significant number of shares may be issued upon the exercise of outstanding
options, warrants, and convertible notes.




37




In
addition, our stock historically has been very thinly traded. Our stock price
may decline if the resale of shares under Rule 144, in addition to the resale of
registered shares, at any time in the future exceeds the market demand for our
stock.





Our
stock price is likely to be highly volatile and may decline.





The
trading prices of the securities of technology companies have been highly
volatile. Accordingly, the trading price of our common stock has been and is
likely to continue to be subject to wide fluctuations. Further, our common stock
has a limited trading history. Factors affecting the trading price of our common
stock generally include the risk factors described in this report.





In
addition, the stock market from time to time has experienced extreme price and
volume fluctuations that have affected the trading prices of many emerging
growth companies. Such fluctuations have often been unrelated or
disproportionate to the operating performance of these companies. These broad
trading fluctuations could adversely affect the trading price of our common
stock.





Our
securities may be subject to “penny stock” rules, which could adversely affect
our stock price and make it more difficult for our stockholders to resell their
stock.





The SEC
has adopted rules that regulate broker-dealer practices in connection with
transactions in penny stocks. Penny stocks are generally equity securities with
a price of less than $5.00 per share (other than securities registered on
certain national securities exchanges or quotation systems, provided that
reports with respect to transactions in such securities are provided by the
exchange or quotation system pursuant to an effective transaction reporting plan
approved by the SEC).





The penny
stock rules require a broker-dealer, prior to a transaction in a penny stock not
otherwise exempt from those rules, to deliver a standardized risk disclosure
document prescribed by the SEC and certain other information related to the
penny stock, the broker-dealer’s compensation in the transaction, and the other
penny stocks in the customer’s account.





In
addition, the penny stock rules require that, prior to a transaction in a penny
stock not otherwise exempt from those rules, the broker-dealer must make a
special written determination that the penny stock is a suitable investment for
the purchaser and receive the purchaser’s written acknowledgment of the receipt
of a risk disclosure statement, a written agreement related to transactions
involving penny stocks, and a signed and dated copy of a written suitability
statement. These disclosure requirements could have the effect of reducing the
trading activity in the secondary market for our stock because it will be
subject to these penny stock rules. Therefore, stockholders may have difficulty
selling those securities.





The
executive management team is critical to the execution of our business plan, and
the frequency of management turnover has been disruptive to the success of the
business.





Our
executive management team has undergone significant changes during 2008 and
2009, including the resignation of our former Chief Executive Officer in
December 2008, our former interim Chief Executive Officers in May 2009 and
November 2009 and the resignation of our former Chief Financial Officer in May
2009, among others. . Furthermore, in light of the prior SEC charges filed
against us, and the related adverse publicity from the criminal trial and
conviction of the Nouris, it may be difficult to attract highly qualified
candidates to serve on our executive management team. If we cannot attract and
retain qualified personnel and integrate new members of our executive management
team effectively into our business, then our business and financial results may
suffer. In addition, all of our executive team works at the same location, which
could make us vulnerable to the loss of our entire team in the event of a
natural or other disaster. We do not maintain key man insurance policies on any
of our employees.





Our
line of credit with Paragon Bank expires on August 14, 2010.





Paragon
Bank has extended our line of credit until August 14, 2010.  If we are
unable to establish a new line of credit, we may have difficulty dealing with
cash flow activities of daily business operations that will be disruptive to the
future success of the business





Item
2.          Unregistered Sales
of Equity Securities and Use of Proceeds





On
February 11, 2010, the Company sold a Note to Atlas in the principal amount of
$500,000, upon substantially the same terms and conditions as the previously
issued Notes, as described in Part I, Item 1, Note 3, Notes Payable,of this
Quarterly Report on Form 10-Q.




There
were no repurchases of any securities during the first quarter of fiscal 2010.





Item
3.             Default
Upon Securities





None.




38





Item
4.             (Removed
and Reserved)





Item
5.             Other
Information





None.





Item
6.            Exhibits





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





Exhibit
      No.
            
            Description





39





EXHIBIT INDEX





Exhibit
      No.
            
            Description3.1
            
            Sixth
      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 January
      20, 2010)4.1
            
            Fourth
      Amendment to Convertible Secured Subordinated Note Purchase Agreement,
      Second Amendment to Convertible Secured Subordinated Promissory Notes and
      Third Amendment to Registration Rights Agreement, dated March 5, 2010, by
      and among Smart Online, Inc. and certain investors (incorporated herein by
      reference to Exhibit 4.8 to our Annual Report on Form 10-K, as filed with
      the SEC on April 15, 2010)4.2
            
            Form
      of Convertible Secured Subordinated Promissory Note to be issued post
      March 5, 2010 (incorporated herein by reference to Exhibit 4.9 to our
      Annual Report on Form 10-K, as filed with the SEC on April 15,
      2010)10.1
            
            Form
      of revised Non-Qualified Stock Option Agreement under Smart Online, Inc.’s
      2004 Equity Compensation Plan (incorporated herein by reference to Exhibit
      10.6 to our Annual Report on Form 10-K, as filed with the SEC on April 15,
      2010)10.2
            
            Form
      of revised Restricted Stock Agreement under Smart Online, Inc.’s 2004
      Equity Compensation Plan (Non-Employee Director) (incorporated herein by
      reference to Exhibit 10.12 to our Annual Report on Form 10-K, as filed
      with the SEC on April 15, 2010)10.3
            
            Smart
      Online, Inc. Revised Board Compensation Policy, effective March 26, 2010
      (incorporated herein by reference to Exhibit 10.21 to our Annual Report on
      Form 10-K, as filed with the SEC on April 15, 2010)10.4
            
            Modification
      Agreement, made as of February 22, 2010, between Smart Online, Inc. and
      Paragon Commercial Bank (incorporated herein by reference to Exhibit 10.35
      to our Annual Report on Form 10-K, as filed with the SEC on April 15,
      2010)10.5
            
            Second
      Amendment to Reimbursement Agreement, dated January 19, 2010, by and
      between Smart Online, Inc. and Atlas Capital, SA(incorporated herein
      by reference to Exhibit 10.38 to our Annual Report on Form 10-K, as filed
      with the SEC on April 15, 2010)31.1
            
            Certification
      of Principal Executive Officer Pursuant to Rule 13a-14(a) as Adopted
      Pursuant to Section 302 of the Sarbanes-Oxley Act of
  200231.2
            
            Certification
      of Principal Financial Officer/Principal Accounting Officer Pursuant to
      Rule 13a-14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200232.1
            
            Certification
      of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as
      Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This
      exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002 and shall not, except to the extent required by that Act, be
      deemed to be incorporated by reference into any document or filed herewith
      for the purposes of liability under the Securities Exchange Act of 1934,
      as amended, or the Securities Act of 1933, as amended, as the case may
      be.32.2
            
            Certification
      of Principal Financial Officer/Principal Accounting 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.





40




SIGNATURES





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





SMART
      ONLINE, INC.By:
            /s/
      Dror ZoreffMay
      14, 2010
            
            Dror
      ZoreffInterim
      Chief Executive OfficerBy:
            /s/
      Thaddeus J. ShalekMay
      14, 2010
            
            Thaddeus
      J. ShalekInterim
      Chief Financial Officer





41




EXHIBIT INDEX





Exhibit
      No.
            
            Description3.1
            
            Sixth
      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 January
      20, 2010)4.1
            
            Fourth
      Amendment to Convertible Secured Subordinated Note Purchase Agreement,
      Second Amendment to Convertible Secured Subordinated Promissory Notes and
      Third Amendment to Registration Rights Agreement, dated March 5, 2010, by
      and among Smart Online, Inc. and certain investors (incorporated herein by
      reference to Exhibit 4.8 to our Annual Report on Form 10-K, as filed with
      the SEC on April 15, 2010)4.2
            
            Form
      of Convertible Secured Subordinated Promissory Note to be issued post
      March 5, 2010 (incorporated herein by reference to Exhibit 4.9 to our
      Annual Report on Form 10-K, as filed with the SEC on April 15,
      2010)10.1
            
            Form
      of revised Non-Qualified Stock Option Agreement under Smart Online, Inc.’s
      2004 Equity Compensation Plan (incorporated herein by reference to Exhibit
      10.6 to our Annual Report on Form 10-K, as filed with the SEC on April 15,
      2010)10.2
            
            Form
      of revised Restricted Stock Agreement under Smart Online, Inc.’s 2004
      Equity Compensation Plan (Non-Employee Director) (incorporated herein by
      reference to Exhibit 10.12 to our Annual Report on Form 10-K, as filed
      with the SEC on April 15, 2010)10.3
            
            Smart
      Online, Inc. Revised Board Compensation Policy, effective March 26, 2010
      (incorporated herein by reference to Exhibit 10.21 to our Annual Report on
      Form 10-K, as filed with the SEC on April 15, 2010)10.4
            
            Modification
      Agreement, made as of February 22, 2010, between Smart Online, Inc. and
      Paragon Commercial Bank (incorporated herein by reference to Exhibit 10.35
      to our Annual Report on Form 10-K, as filed with the SEC on April 15,
      2010)10.5
            
            Second
      Amendment to Reimbursement Agreement, dated January 19, 2010, by and
      between Smart Online, Inc. and Atlas Capital, SA(incorporated herein
      by reference to Exhibit 10.38 to our Annual Report on Form 10-K, as filed
      with the SEC on April 15, 2010)31.1
            
            Certification
      of Principal Executive Officer Pursuant to Rule 13a-14(a) as Adopted
      Pursuant to Section 302 of the Sarbanes-Oxley Act of
  200231.2
            
            Certification
      of Principal Financial Officer/Principal Accounting Officer Pursuant to
      Rule 13a-14(a) as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
      Act of 200232.1
            
            Certification
      of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as
      Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This
      exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley
      Act of 2002 and shall not, except to the extent required by that Act, be
      deemed to be incorporated by reference into any document or filed herewith
      for the purposes of liability under the Securities Exchange Act of 1934,
      as amended, or the Securities Act of 1933, as amended, as the case may
      be.32.2
            
            Certification
      of Principal Financial Officer/Principal Accounting 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.





42