**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


**_________________**





**FORM
      10-Q**


**_________________**


**(Mark
      One)**


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





**For
      the quarterly period ended June 30, 2008**





**OR**





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





**Commission
      File Number: 001-32634**


**_________________**





**SMART
      ONLINE, INC.**


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


**_________________**





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








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





**(919)
      765-5000**


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


**_________________**





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





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




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




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act).


Yes o No x





As
      of
      August 8, 2008, there were approximately 18,325,606 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 June 30, 2008





**TABLE
      OF CONTENTS**




Page
                No.**PART
                I - FINANCIAL INFORMATION**Item
                1.
            Financial
                StatementsConsolidated
                Balance Sheets as of June 30, 2008 (unaudited) and December 31,
                2007
            3Consolidated
                Statements of Operations (unaudited) for the three and six months
                ended
                June 30, 2008 and 2007
            4Consolidated
                Statements of Cash Flows (unaudited) for the three and six months
                ended
                June 30, 2008 and 2007
            5Notes
                to Consolidated Financial Statements (unaudited)
            6Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            18Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            28Item
                4.
            Controls
                and Procedures
            28Item
                4T.
            Controls
                and Procedures
            28**PART
                II - OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            29Item
                1A.
            Risk
                Factors
            30Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            35Item
                5.
            Other
                Information
            36Item
                6.
            Exhibits
            38Signatures
            39




2




**PART
      I - FINANCIAL INFORMATION**





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





**SMART
      ONLINE, INC.**


**CONSOLIDATED
      BALANCE SHEETS**





**June
                30,**
              **2008**
              **(unaudited)**
            
            **December 31,**
              **2007****Assets**CURRENT
                ASSETS:Cash
                and Cash Equivalents
            
            $
            183,045
            
            $
            3,473,959Accounts
                Receivable, Net
            
            
            742,309
            
            
            815,102Contract
                Receivable (See Note 3)
            
            
            320,000
            
            
            -Note
                Receivable
            
            
            55,000
            
            
            55,000Costs
                in Excess of Billings
            
            
            60,437
            
            
            -Prepaid
                Expenses
            
            
            128,999
            
            
            90,886Deferred
                Financing Costs (See Note 3)
            
            
            75,307
            
            
            301,249Total
                Current Assets
            
            
            1,565,097
            
            
            4,736,196PROPERTY
                AND EQUIPMENT, Net
            
            
            180,370
            
            
            174,619LONG-TERM
                PORTION OF CONTRACT RECEIVABLE (See Note 3)
            
            
            160,000
            
            
            -LONG-TERM
                PORTION OF NOTE RECEIVABLE
            
            
            225,000
            
            
            225,000INTANGIBLE
                ASSETS, Net
            
            
            2,512,746
            
            
            2,882,055GOODWILL
            
            
            2,696,642
            
            
            2,696,642OTHER
                ASSETS
            
            
            34,751
            
            
            60,311TOTAL
                ASSETS
            
            $
            7,374,606
            
            $
            10,774,823**Liabilities
                and Stockholders’ Equity**CURRENT
                LIABILITIES:Accounts
                Payable
            
            $
            478,007
            
            $
            628,370Notes
                Payable (See Note 4)
            
            
            1,859,450
            
            
            2,287,682Deferred
                Revenue (See Note 3)
            
            
            250,895
            
            
            329,805Accrued
                Liabilities (See Note 3)
            
            
            403,309
            
            
            603,338Total
                Current Liabilities
            
            
            2,991,661
            
            
            3,849,195LONG-TERM
                LIABILITIES:Long-Term
                Portion of Notes Payable (See Note 4)
            
            
            3,340,824
            
            
            3,313,903Deferred
                Revenue (See Note 3)
            
            
            321,960
            
            
            247,312Total
                Long-Term Liabilities
            
            
            3,662,784
            
            
            3,561,215Total
                Liabilities
            
            
            6,654,445
            
            
            7,410,410COMMITMENTS
                AND CONTINGENCIES (See Note 7)STOCKHOLDERS’
                EQUITY:Common
                Stock, $.001 Par Value, 45,000,000 Shares Authorized, Shares Issued
                and
                Outstanding:June
                30, 2008 - 18,347,273; December 31, 2007 - 18,159,768
            
            
            18,347
            
            
            18,160Additional
                Paid-in Capital
            
            
            66,690,682
            
            
            66,202,179Accumulated
                Deficit
            
            
            (65,988,868
            )
            
            (62,855,926
            )Total
                Stockholders’ Equity
            
            
            720,161
            
            
            3,364,413TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            $
            7,374,606
            
            $
            10,774,823




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




3


**SMART
      ONLINE, INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS (unaudited)**




**Three
                Months Ended**
            
            **Six
                Months Ended****June
                30, 2008**
            
            **June
                30, 2007**
            
            **June
                30, 2008**
            
            **June
                30, 2007**REVENUES:Subscription
                Fees
            
            $
            747,068
            
            $
            576,600
            
            $
            1,489,907
            
            $
            1,209,583Professional
                Service Fees
            
            
            953,640
            
            
            317,900
            
            
            1,508,884
            
            
            606,479License
                Fees
            
            
            3,750
            
            
            280,000
            
            
            103,750
            
            
            280,000Other
                Revenue
            
            
            21,320
            
            
            29,429
            
            
            45,975
            
            
            50,254Total
                Revenues
            
            $
            1,725,778
            
            $
            1,203,929
            
            $
            3,148,516
            
            $
            2,146,316COST
                OF REVENUES
            
            $
            226,293
            
            $
            111,489
            
            $
            412,861
            
            $
            187,909GROSS
                PROFIT
            
            $
            1,499,485
            
            $
            1,092,440
            
            $
            2,735,655
            
            $
            1,958,407OPERATING
                EXPENSES:General
                and Administrative
            
            
            1,125,573
            
            
            1,051,314
            
            
            2,481,589
            
            
            2,164,005Sales
                and Marketing
            
            
            752,638
            
            
            473,668
            
            
            1,427,469
            
            
            942,915Research
                and Development
            
            
            745,923
            
            
            685,915
            
            
            1,606,372
            
            
            1,262,610Total
                Operating Expenses
            
            $
            2,624,134
            
            $
            2,210,897
            
            $
            5,515,430
            
            $
            4,369,530LOSS
                FROM CONTINUING OPERATIONS
            
            
            (1,124,649
            )
            
            (1,118,457
            )
            
            (2,779,775
            )
            
            (2,411,123
            )OTHER
                INCOME (EXPENSE):Interest
                Expense, Net
            
            
            (190,922
            )
            
            (126,759
            )
            
            (369,236
            )
            
            (261,787
            )Other
                Income
            
            
            13,512
            
            
            30,478
            
            
            16,069
            
            
            143,808Total
                Other Income (Expense)
            
            $
            (177,410
            )
            $
            (96,281
            )
            $
            (353,167
            )
            $
            (113,379
            )NET
                LOSS FROM OPERATIONS
            
            
            (1,302,059
            )
            
            (1,214,738
            )
            
            (3,132,942
            )
            
            (2,524,502
            )NET
                LOSS ATTRIBUTED TO COMMON STOCKHOLDERS
            
            $
            (1,302,059
            )
            
            (1,214,738
            )
            $
            (3,132,942
            )
            $
            (2,524,502
            )NET
                LOSS PER SHARE:Continuing
                OperationsBasic
                and Fully Diluted
            
            $
            (0.07
            )
            $
            (0.07
            )
            $
            (0.17
            )
            $
            (0.15
            )Net
                Loss Attributed to Common StockholdersBasic
                and Fully Diluted
            
            $
            (0.07
            )
            
            (0.07
            )
            
            (0.17
            )
            
            (0.15
            )SHARES
                USED IN COMPUTING NET LOSS PER SHAREBasic
                and Fully Diluted
            
            
            18,265,367
            
            
            17,252,639
            
            
            18,233,269
            
            
            16,728,010




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




4




**SMART
      ONLINE, INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**(unaudited)**




**Three
                Months**
              **Ended**
              **June
                30, 2008**
            
            **Three
                Months**
              **Ended**
              **June
                30, 2007**
            
            **Six
                Months**
              **Ended**
              **June
                30, 2008**
            
            **Six
                Months**
              **Ended**
              **June
                30, 2007**CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                Loss
            
            $
            (1,302,059
            )
            $
            (1,214,738
            )
            $
            (3,132,942
            )
            $
            (2,524,502
            )Adjustments
                to reconcile Net Loss to Net Cash used in Operating
                Activities:Depreciation
                and Amortization
            
            
            207,893
            
            
            210,652
            
            
            415,523
            
            
            420,418Amortization
                of Deferred Financing Costs
            
            
            112,971
            
            
            112,971
            
            
            225,942
            
            
            207,112Bad
                Debt Expense
            
            
            9,532
            
            
            -
            
            
            45,000
            
            
            -Stock-Based
                Compensation Expense
            
            
            89,645
            
            
            223,285
            
            
            260,144
            
            
            380,018Registration
                Rights Penalty
            
            
            -
            
            
            -
            
            
            -
            
            
            (320,632
            )Gain
                on Debt Forgiveness
            
            
            -
            
            
            -
            
            
            -
            
            
            (4,600
            )Gain
                on Disposal of Assets
            
            
            -
            
            
            -
            
            
            (2,665
            )
            
            -Changes
                in Assets and Liabilities:Accounts
                Receivable
            
            
            (474,056
            )
            
            (650,160
            )
            
            (452,207
            )
            
            (686,651
            )Costs
                in Excess of Billings
            
            
            (60,437
            )
            
            -
            
            
            (60,437
            )
            
            -Prepaid
                Expenses
            
            
            2,645
            
            
            10,938
            
            
            (38,113
            )
            
            10,035Other
                Assets
            
            
            10,560
            
            
            -
            
            
            25,560
            
            
            (1,760
            )Deferred
                Revenue
            
            
            85,014
            
            
            432,027
            
            
            (4,262
            )
            
            380,476Accounts
                Payable
            
            
            (65,938
            )
            
            (75,827
            )
            
            (150,363
            )
            
            (86,495
            )Accrued
                and Other Expenses
            
            
            (112,874
            )
            
            1,090
            
            
            28,517
            
            
            44,312Net
                Cash used in Operating Activities
            
            $
            (1,497,104
            )
            $
            (949,762
            )
            $
            (2,840,303
            )
            $
            (2,182,269
            )CASH
                FLOWS FROM INVESTING ACTIVITIES:Purchases
                of Furniture and Equipment
            
            
            (52,363
            )
            
            (41,217
            )
            
            (61,800
            )
            
            (51,976
            )Purchase
                of Tradename
            
            
            -
            
            
            (2,033
            )
            
            -
            
            
            (2,033
            )Proceeds
                from Sale of Furniture and Equipment
            
            
            -
            
            
            -
            
            
            12,500
            
            
            -Net
                Cash used in Investing Activities
            
            $
            (52,363
            )
            $
            (43,250
            )
            $
            (49,300
            )
            $
            (54,009
            )CASH
                FLOWS FROM FINANCING ACTIVITIES:Repayments
                on Notes Payable
            
            
            (2,461
            )
            
            (305,315
            )
            
            (2,284,526
            )
            
            (1,559,272
            )Debt
                Borrowings
            
            
            1,383,215
            
            
            -
            
            
            1,883,215
            
            
            1,450,000Issuance
                of Common Stock
            
            
            -
            
            
            -
            
            
            -
            
            
            5,748,607Expenses
                Related to Form S-1 Filing
            
            
            -
            
            
            (101,709
            )
            
            -
            
            
            (101,709
            )Net
                Cash provided by (used in) Financing Activities
            
            $
            1,380,754
            
            $
            (407,024
            )
            $
            (401,311
            )
            $
            5,537,626NET
                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            $
            (168,713
            )
            $
            (1,400,036
            )
            $
            (3,290,914
            )
            $
            3,301,348CASH
                AND CASH EQUIVALENTS,
              BEGINNING
                OF PERIOD
            
            $
            351,758
            
            $
            5,028,289
            
            $
            3,473,959
            
            $
            326,905CASH
                AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            183,045
            
            $
            3,628,253
            
            $
            183,045
            
            $
            3,628,253Supplemental
                Disclosures of Cash Flow Information:Cash
                Paid During the Period for:Interest
            
            $
            190,215
            
            $
            109,596
            
            $
            383,064
            
            $
            182,866Taxes
            
            $
            17,350
            
            $
            -
            
            $
            35,370
            
            $
            -Supplemental
                Schedule of Non-cash Financing Activities:Conversion
                of Debt to Equity
            
            $
            -
            
            $
            -
            
            $
            228,546
            
            $
            -




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




5


**Smart
      Online, Inc.**


**Consolidated
      Financial Statements - Unaudited**





**1.**
            **Summary
                of Business and Significant Accounting
                Policies**





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





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





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




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




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





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





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





***Revenue
      Recognition*** -
      The
      Company derives revenue from the license of software platforms along with the
      sale of associated application development services and maintenance, consulting,
      hosting services, and subscriptions. The arrangement may include delivery in
      multiple-element arrangements if the customer purchases a combination of
      products and/or services. The Company uses the residual method pursuant to
      American Institute of Certified Public Accountants (“AICPA”) Statement of
      Position 97-2, *Software Revenue Recognition* (“SOP
      97-2”), as amended. This method allows 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.




6




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





1.
                persuasive
                    evidence of an arrangement
                    exists





2.
                delivery
                    has occurred





3.
                the
                    fee is fixed or
                    determinable


4.
                collectibility
                    is probable





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





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





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





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





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




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




7




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





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





***Advertising
      Costs*** - The
      Company expenses all advertising costs as they are incurred. The amounts charged
      to sales and marketing expense during the second quarter of 2008 and 2007 were
      $9,948 and $12,095, respectively. During the first six months of 2008 and 2007,
      advertising costs totaling $12,410 and $15,669, respectively, were included
      in
      sales and marketing expense.





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





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





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





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




**Three
                  Months Ended**
              
              **Six
                  Months Ended****June
                  30, 2008**
              
              **June
                  30, 2007**
              
              **June
                  30, 2008**
              
              **June
                  30, 2007**Compensation
                  expense included in G&A expense related to stock
                  options
              
              $
              26,942
              
              $
              154,735
              
              $
              75,204
              
              $
              311,468Compensation
                  expense included in G&A expense related to restricted stock
                  awards
              
              
              62,703
              
              
              68,550
              
              
              184,940
              
              
              68,550Total
                  SFAS No. 123R Expense
              
              $
              89,645
              
              $
              223,285
              
              $
              260,144
              
              $
              380,018




8




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




**Three
                Months Ended**
            
            
            **Six
                Months Ended****June
                30, 2008**
            
            
            **June
                30, 2007**
            
            
            **June
                30, 2008**
            
            
            **June
                30, 2007**Dividend
                yield
            
            
            0.0
            %
            
            0.0
            %
            
            0.0
            %
            
            0.0
            %Expected
                volatility
            
            
            40
            %
            
            150
            %
            
            50
            %
            
            150
            %Risk
                free interest rate
            
            
            4.45
            %
            
            4.92
            %
            
            4.55
            %
            
            4.92
            %Expected
                lives (years)
            
            
            4
            
            
            5
            
            
            5
            
            
            5





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





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





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





**Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**BALANCE,
                December 31, 2007
            
            
            1,644,300
            
            $
            5.07Granted
            
            
            20,000
            
            
            3.15Forfeited
            
            
            (1,019,400
            )
            
            5.74Exercised
            
            
            (250,000
            )
            
            1.43BALANCE,
                June 30, 2008
            
            
            394,900
            
            $
            5.51





***Recently
      Issued Accounting Pronouncements*** - In
      March
      2008, the Financial Accounting Standards Board issued SFAS No.
      161, *Disclosures
      about Derivative Instruments and Hedging Activities* (“SFAS
      No. 161”), **** which
      amends and expands the disclosure requirements of SFAS No. 133, *Accounting
      for Derivative Instruments and Hedging Activities,* with the
      intent to provide users of financial statements with an enhanced understanding
      of how and why an entity uses derivative instruments, how the derivative
      instruments and the related hedged items are accounted for, and how the related
      hedged items affect an entity’s financial position, performance, and cash flows.
      SFAS No. 161 is effective for financial statements for fiscal years and interim
      periods beginning after November 15, 2008. Management believes that SFAS No.
      161
      will have no impact on the financial statements of the Company once adopted
      as
      the Company currently does not use derivative instruments.





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





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





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




9




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





***Accounts
      Receivable, Net***





The
      Company typically invoices its customers on a monthly basis for professional
      services and either upfront or annually for licenses. The
      Company evaluates the need for an allowance for doubtful accounts based on
      specifically identified amounts that management believes to be uncollectible.
      Management also records an additional allowance based on management’s assessment
      of the general financial conditions affecting its customer base. If actual
      collections experience changes, revisions to the allowance may be required.
      Based on these criteria, management determined that no allowance for doubtful
      accounts was required as of December 31, 2007, and management has recorded
      an
      allowance of $45,000 as of June 30, 2008.





***Contract
      Receivable***





From
      time
      to time, the Company, as part of its negotiated contracts, has granted extended
      payment terms to its strategic partners. As payments become due under the terms
      of the contract, they are invoiced and reclassified as accounts receivable.
      During the second quarter of 2008, the Company entered into a web services
      agreement with a new customer that provided for extended payment terms related
      to both professional services and the grant of a software license. As of June
      30, 2008, the Company has classified $160,000 of this receivable as
      noncurrent.





***Deferred
      Financing Costs***





To
      assist
      the Company in securing a modification to its line of credit with
      Wachovia Bank, NA (“Wachovia”), Atlas Capital, SA (“Atlas”) provided Wachovia
      with a standby letter of credit. In exchange for Atlas providing Wachovia with
      the modified letter of credit, on January 15, 2007 the Company issued Atlas
      a
      warrant to purchase 444,444 shares of common stock at $2.70 per share. The
      fair
      value of that warrant was $734,303 as measured using the Black-Scholes
      option-pricing model at the time the warrant was issued. Such amount was
      recorded as deferred financing costs and is being amortized to interest expense
      in the amount of $37,657 per month over the remaining period of the modified
      line of credit, which is scheduled to expire in August 2008. In February 2008,
      the Wachovia line of credit was replaced by a new line of credit with Paragon
      Commercial Bank (“Paragon”) as described in Note 4, “Notes Payable.”  Atlas
      agreed to provide Paragon a new standby letter of credit and the Company agreed
      to amend the Atlas warrant agreement to provide that the warrant is exercisable
      within 30 business days of the termination of the Paragon line of credit or
      if
      the Company is in default under the terms of the line of credit with
      Paragon. As of June 30, 2008, the remaining $75,307 of deferred financing costs
      which will be fully amortized to interest expense over the third quarter of
      fiscal 2008 were classified as current assets.





***Accrued
      Liabilities***





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





At
      June
      30, 2008, accrued liabilities totaled $403,309. This amount consisted primarily
      of $162,333 of liability accrued related to the above noted development of
      the
      Company’s custom accounting application, $137,500 related to legal reserves (see
      Note 7, “Commitments and Contingencies”), and $55,000 related to taxes payable
      due to vesting of restricted stock.




10





***Deferred
      Revenue***





Deferred
      revenue comprises the following items:





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





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





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





**June
                30,**
              **2008**
            
            **December
                31,**
              **2007**Subscription
                Fees
            
            $
            292,855
            
            $
            197,117License
                Fees
            
            
            280,000
            
            
            380,000BALANCE
            
            $
            572,855
            
            $
            577,117Current
                Portion
            
            $
            250,895
            
            $
            329,805Noncurrent
                Portion
            
            
            321,960
            
            
            247,312Total
            
            $
            572,855
            
            $
            577,117





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





***Convertible
      Notes***





On
      November 14, 2007, in an initial closing, the Company sold $3.3 million
      aggregate principal amount of secured subordinated convertible notes due
      November 14, 2010. In addition, the noteholders committed to purchase on a
      pro
      rata basis up to $5.2 million aggregate principal of secured subordinated notes
      in future closings upon approval and call by the Company’s Board of Directors.
      The Company is obligated to pay interest on the notes at an annualized rate
      of
      8% payable in quarterly installments commencing on February 14, 2008. The
      Company is not permitted to prepay the notes without approval of the holders
      of
      at least a majority of the principal amount of the notes then outstanding.





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





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





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




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




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




·
            issued
                in any additional closings shall be the lesser of a 20% premium above
                the
                average of the closing bid and asked prices of shares of the Company’s
                common stock quoted in the Over-The-Counter Market Summary (or, if
                the
                Company’s shares are traded on the Nasdaq Stock Market or another
                exchange, the closing price of shares of the Company’s common stock quoted
                on such exchange) averaged over five trading days prior to the respective
                additional closing date.





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




11




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





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





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





***Line
      of Credit***





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





On
      February 20, 2008, the Company entered into a revolving credit arrangement
      with
      Paragon. The line of credit advanced by Paragon is $2.47 million and can be
      used
      for general working capital. Any advances made on the line of credit must be
      paid off no later than February 19, 2009, with monthly payments being applied
      first to accrued interest and then to principal. The interest shall accrue
      on
      the unpaid principal balance at the Wall Street Journal’s published prime rate
      minus one half percent. The line of credit is secured by an irrevocable standby
      letter of credit in the amount of $2.5 million issued by HSBC Private Bank
      (Suisse) SA with Atlas, a current stockholder of the Company, as account party.
      The Company also has agreed with Atlas that in the event of a default by the
      Company in the repayment of the line of credit that results in the letter of
      credit being drawn, the Company shall reimburse Atlas any sums that Atlas is
      required to pay under such letter of credit. At the sole discretion of the
      Company, these payments may be made in cash or by issuing shares of the
      Company’s common stock at a set per share price of $2.50.





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





As
      of
      June 30, 2008, the Company had notes payable totaling $5,200,274. The detail
      of
      these notes is as follows:





**Note Description**
            
            **Short-Term**
              **Portion**
            
            **Long-Term**
              **Portion**
            
            **TOTAL**
            
            **Maturity**
            
            **Rate**Paragon
                Commercial
              Bank
                Credit Line
            
            $
            1,835,000
            
            $
            -
            
            $
            1,835,000
            
            
            Feb
                ‘09
            
            
            Prime
                less 0.5
            %Various
                Capital Leases
            
            
            24,450
            
            
            40,824
            
            
            65,274
            
            
            Various
            
            
            11-19
            %Convertible
                Notes
            
            
            -
            
            
            3,300,000
            
            
            3,300,000
            
            
            Nov
                ‘10
            
            
            8.0
            %TOTAL
            
            $
            1,859,450
            
            $
            3,340,824
            
            $
            5,200,274





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




***Common
      Stock***




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




12




During
      the first six months of 2008 and in conjunction with their termination of
      employment, the Company accelerated vesting with respect to 31,250 shares of
      restricted stock previously issued to the Company’s former Chief Financial
      Officer, former Chief Operating Officer, and former in-house legal counsel.
      The
      Company recorded $92,281 of expense related to the accelerated vesting of these
      shares including $31,500 that had been accrued during the fourth quarter of
      2007. Additionally, net of the accelerated vesting discussed above,
      41,791 ****** shares
      of
      restricted stock were accounted for as forfeited during the first six months
      of
      2008 due to resignations and terminations. The forfeited shares included 15,625
      shares issued to the former Chief Operating Officer, 10,000 shares issued to
      the
      former Chief Financial Officer, 7,500 shares issued to a former director, and
      8,666 shares issued to former employees.





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




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





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





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




13





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





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




***Equity
      Compensation Plans***




In
      June
      2007, the Company temporarily limited the issuance of shares of its common
      stock
      reserved under the 2004 Equity Compensation Plan to awards of restricted or
      unrestricted stock and in June 2008 made options available for grant under
      the
      plan again. In January 2008, a former officer of the Company exercised options
      to purchase 69,930 shares of the Company’s common stock in a cashless exercise
      whereby the former officer tendered to the Company 38,462 shares of common
      stock
      previously held by the former officer. In June 2008, the same former officer
      exercised options to purchase 180,070 shares of the Company’s common stock in a
      cashless exercise whereby the former officer tendered to the Company 80,469
      shares of the Company’s common stock previously held by the former officer. Also
      in June 2008, a member
      of
      the Board of Directors was granted an option to purchase 20,000 shares of common
      stock under the 2004 Equity Compensation Plan. During the first six months
      of
      2008, options
      to purchase 1,019,400 shares of common stock at prices ranging from $1.43 to
      $9.82 were forfeited by former employees, officers, directors, and consultants
      of the Company.





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







**Currently
                Exercisable****Exercise**
              **Price**
            
            
            **Number of**
              **Shares**
              **Outstanding**
            
            
            **Average**
              **Remaining**
              **Contractual**
              **Life
                (Years)**
            
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**
            
            
            **Number of**
              **Shares**
            
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**From
                $1.30 to $1.43
            
            
            75,000
            
            
            0.6
            
            $
            1.30
            
            
            75,000
            
            $
            1.30From
                $2.50 to $3.50
            
            
            85,000
            
            
            7.4
            
            $
            3.19
            
            
            59,000
            
            $
            3.18$5.00
            
            
            31,200
            
            
            7.0
            
            $
            5.00
            
            
            21,200
            
            $
            5.00$7.00
            
            
            75,000
            
            
            7.3
            
            $
            7.00
            
            
            75,000
            
            $
            7.00From
                $8.61 to $9.00
            
            
            128,500
            
            
            6.8
            
            $
            8.77
            
            
            56,200
            
            $
            8.79$9.60
            
            
            200
            
            
            7.2
            
            $
            9.60
            
            
            80
            
            $
            9.60





***Dividends***





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




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





The
      Company derives a significant portion of its revenues from certain customer
      relationships. The following is a summary of customers that represent greater
      than ten percent of total revenues for their respective time
      periods:




14




Three
                Months Ended
              June
                30, 2008Revenue
                Type
            
            
            Revenues
            
            
            %
                of Total
              RevenuesCustomer
                A
            
            
            Subscription
            
            $
            358,607
            
            
            21
            %Customer
                B
            
            
            Subscription
            
            $
            307,913
            
            
            18
            %Customer
                C
            
            
            License
                Fees/Professional Services
            
            $
            182,068
            
            
            11
            %Customer
                D
            
            
            Professional
                Services
            
            $
            401,805
            
            
            23
            %Customer
                E
            
            
            Professional
                Services
            
            $
            348,750
            
            
            20
            %Others
            
            
            Various
            
            $
            126,635
            
            
            7
            %Total
            
            
            
            
            $
            1,725,778
            
            
            100
            %







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







Six
                  Months Ended
                June
                  30, 2008Revenue
                  Type
              
              
              Revenues
              
              
              %
                  of Total
                RevenuesCustomer
                  A
              
              
              Subscription
              
              $
              659,941
              
              
              21
              %Customer
                  B
              
              
              Subscription
              
              $
              669,003
              
              
              21
              %Customer
                  C
              
              
              License
                  Fees/Professional Services
              
              $
              398,351
              
              
              13
              %Customer
                  D
              
              
              Professional
                  Services
              
              $
              784,996
              
              
              25
              %Customer
                  E
              
              
              Professional
                  Services
              
              $
              348,750
              
              
              11
              %Others
              
              
              Various
              
              $
              287,475
              
              
              9
              %Total
              
              
              
              
              $
              3,148,516
              
              
              100
              %


15




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





As
      of
      June 30, 2008, three customers accounted for 54%, 24%, and 20% of net
      receivables, respectively. As of December 31, 2007, the Company had three
      customers that accounted for 42%, 28% and 17% of net receivables,
      respectively.





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





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





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





In
      August
      2005, the Company entered into a software assignment and development agreement
      with the developer of a customized accounting software application.  In
      connection with this agreement, the developer would be paid up to $512,500
      and
      issued up to 32,395 shares of the Company’s common stock based upon the
      developer attaining certain milestones.  As of June 30, 2008, the Company
      had paid $429,167 and issued 3,473 shares of common stock related to this
      obligation.





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





During
      April 2008, the Company received approximately $95,000 in insurance
      reimbursement for previously disputed legal expenses primarily related to
      previously disclosed SEC matters. Additional legal
      expenses related to the Company’s securities litigation matters are
      currently being reviewed by the insurance carrier. The
      Company contends that these legal expenses should be reimbursed by the insurance
      carrier. Because the outcome of this dispute is unclear, the Company has
      expensed all legal costs incurred with respect to the SEC matters and the
      Company’s 2006 internal investigation, and the Company will account for any
      insurance reimbursement, should there be any, in the period such amounts are
      reimbursed.





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




16




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





*Restructuring
      of Michigan Operations* .
      On July
      1, 2008, the Company’s management initiated a restructuring program that is
      aimed at reducing operating, general and administrative expenses in fiscal
      2008
      by consolidating significant operations in its location in Durham, North
      Carolina near Research Triangle Park. The plan includes severance of certain
      of
      the Company’s employees located in Grand Rapids, Michigan.





The
      Company initiated this program as part of its ongoing efforts to realign certain
      production and development functions and eliminate redundant administrative
      functions as well as proactively and prudently manage operating, general and
      administrative costs. The Company expects to record a one-time restructuring
      charge of approximately $53,000 during the third quarter of fiscal 2008,
      primarily as a result of certain one-time termination benefits that will be
      provided in connection with the plan as well as costs associated with the
      continued employment of three employees in Grand Rapids. In addition, the
      Company has initiated an impairment evaluation of goodwill and intangible assets
      related to the Grand Rapids operations. The Company has not completed this
      evaluation and therefore has not determined whether any portion of its recorded
      goodwill and/or intangible assets balance is impaired.





*Suit
      Against Former Employee* .
      On July
      14, 2008, the Company filed a civil action against a former employee in the
      General Court of Justice, Superior Court Division, Durham County, North
      Carolina. The complaint alleges that the former employee embezzled funds from
      the Company in the amount of $105,600 and asserts claims for conversion and
      unfair trade practices. The lawsuit seeks recovery for the embezzled funds,
      plus
      punitive damages or treble damages, interest, and attorneys’ fees.





*Appointment
      of Chief Financial Officer* .
      On July
      15, 2008, the Company’s Board of Directors unanimously appointed Timothy L.
      Krist as the Company’s Chief Financial Officer. Effective July 9, 2008, the
      Company notified George Cahill, its Interim Chief Financial Officer, that
      pursuant to Paragraph 3 of the Consulting Agreement between the Company and
      Mr.
      Cahill dated April 22, 2008, the Company was exercising its right to terminate
      his consulting services. As previously reported, Mr. Cahill was serving in
      this
      position on a temporary basis during the Company’s search for a permanent Chief
      Financial Officer.





*Convertible
      Note Financing* .
      On
      August 12, 2008, the Company exercised its option to sell $1.5 million aggregate
      principal amount of additional secured subordinated convertible notes due
      November 14, 2010 (the “Additional Notes”) with substantially the same terms and
      conditions as the notes issued on November 14, 2007, as described in Note 4,
      “Notes Payable,” above. The Company is obligated to pay interest on the
      Additional Notes at an annualized rate of 8% payable in quarterly installments
      commencing on November 12, 2008.





The
      Additional Notes and the common stock into which they may be converted have
      not
      been registered under the Securities Act or the securities laws of any other
      jurisdiction. As a result, offers and sales of the Additional Notes were made
      pursuant to Regulation D of the Securities Act and only made to accredited
      investors that were existing stockholders of the Company. The investors are
      (i)
      Atlas, which originally recommended Shlomo Elia, one of the Company’s directors,
      for appointment to the Board of Directors; and (ii) Crystal Management Ltd.,
      which is owned by Doron Roethler, the Company’s Chairman of the Board of
      Directors and bond representative for the noteholders.





The
      Company plans to use the proceeds to meet ongoing working capital and capital
      spending requirements.





In
      connection with the sale of the Additional Notes, the noteholders holding a
      majority of the aggregate principal amount of the notes outstanding agreed
      to
      increase the aggregate principal amount of secured subordinated convertible
      notes that they are committed to purchase from $8.5 million to $15.3 million,
      of
      which $4.8 million is currently outstanding.





*Insurance
      Reimbursement* .
      On
      August 7, 2008, the Company and its prior insurance carrier agreed that the
      carrier would reimburse it $300,000 for previously disputed legal expenses
      primarily related to its previously disclosed SEC matters. The reimbursement
      covered all disputed Company expenses prior to September 11, 2007 as well as
      certain enumerated invoices in dispute for the balance of 2007.




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,” and elsewhere in this report, for factors that may cause actual
      results to be different than those expressed in these forward-looking
      statements. Except as required by law, we undertake no obligation to revise
      or
      update publicly any forward-looking statements for any reason.*





**Overview**





We
      develop and market software products and services delivered via a
      Software-as-a-Service, or SaaS, model and targeted to small businesses. We
      reach
      small businesses primarily through arrangements with large corporations that
      private label our software applications through their corporate websites. We
      believe these relationships provide a cost and time efficient way to market
      to a
      diverse, fragmented, yet very sizeable small business sector.




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





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





**Sources
      of Revenue**





We
      derive
      revenues from the following sources:





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




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




·
                Professional
                    service fees - fees related to consulting services that complement
                    our
                    other products and
                    applications




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




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





Licensing
      revenue consists of perpetual or term license agreements for the use of the
      Smart Online platform, the Smart Commerce platform, or any of our applications.
      We are currently focused on bundling a license component with our other
      offerings in future transactions.





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.





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





**Cost
      of Revenues**





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





**Operating
      Expenses**





Throughout
      2008, we expect our primary business initiatives to include increasing
      subscription revenue, making organizational improvements, and concentrating
      our
      development efforts on enhancements and customization of our proprietary
      platforms and applications.




*General
      and Administrative* .
      General
      and administrative expenses consist of salaries and related expenses for
      executive, finance and accounting, legal, human resources, and information
      technology personnel; professional fees; and other corporate expenses, including
      facilities costs. We anticipate general and administrative expenses will
      increase as we add personnel and incur additional professional fees and
      insurance costs related to the growth of our business and our operations as
      a
      public company. We expect to continue to incur material costs in 2008 related
      to
      the civil and criminal complaints filed in September 2007, described in detail
      in Part I, Item 3, “Legal Proceedings,” in our Annual Report on Form 10-K for
      the year ended December 31, 2007, and our implementation of the requirements
      of
      Section 404 of the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley.





*Sales
      and Marketing* .
      Historically, we spent limited funds on marketing, advertising, and public
      relations, particularly due to our business model of partnering with established
      companies with extensive small business customer bases. In June 2008, we engaged
      a public relations firm and, as a result, we expect our public relations costs
      to increase in the second half of 2008. We also expect sales and marketing
      expense to increase in the balance of 2008 due to targeting new partnerships,
      development of channel partner enablement programs, additional sales personnel,
      and the various percentages of revenues we may be required to pay to future
      partners as marketing fees.




19





*Research
      and Development* .
      Historically, we have not capitalized any costs associated with the development
      of our products and platforms. Statement of Financial Accounting Standard,
      or
      SFAS, No. 86, *Accounting
      for the Costs of Computer Software to Be Sold, Leased, or Otherwise
      Marketed* ,
      requires capitalization of certain software development costs subsequent to
      the
      establishment of technological feasibility. Because any such costs that would
      be
      capitalized following the establishment of technological feasibility would
      immediately be written off due to uncertain realizability, all such costs have
      been recorded as research and development costs and expensed as incurred.
      Because of our proprietary, scalable, and secure multi-user architecture, we
      are
      able to provide all customers with a service based on a single version of our
      application. As a result, we do not have to maintain multiple versions, which
      enables us to have relatively low research and development expenses as compared
      to traditional enterprise software business models. We expect that in the
      future, research and development expenses will increase substantially in
      absolute dollars, but decrease as a percentage of total revenue as we hire
      additional personnel, whether internally or by outsourcing, as part of our
      ongoing commitment to furthering our technical skill set and enhancing and
      customizing our platforms and applications. In addition, we continue to conduct
      an evaluation of our technology, security, platforms, and applications in an
      effort to document and improve upon our current product offerings and determine
      which applications, if any, should be discontinued. We expect this process
      to
      continue through the third quarter of 2008.





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




**Critical
      Accounting Policies and Estimates**





Our
      discussion and analysis of financial condition and results of operations are
      based upon our consolidated financial statements, which we prepared in
      accordance with accounting principles generally accepted in the United States.
      The preparation of these financial statements requires us to make estimates
      and
      judgments that affect the reported amounts of assets, liabilities, revenues,
      and
      expenses, and related disclosures of contingent assets and liabilities.
“Critical accounting policies and estimates” are defined as those most important
      to the financial statement presentation and that require the most difficult,
      subjective, or complex judgments. We base our estimates on historical experience
      and on various other factors that we believe to be reasonable under the
      circumstances, the results of which form the basis for making judgments about
      the carrying value of assets and liabilities that are not readily apparent
      from
      other sources. Under different assumptions and/or conditions, actual results
      of
      operations may materially differ. We periodically reevaluate our critical
      accounting policies and estimates, including those related to revenue
      recognition, provision for doubtful accounts and sales returns, expected lives
      of customer relationships, useful lives of intangible assets and property and
      equipment, provision for income taxes, valuation of deferred tax assets and
      liabilities, and contingencies and litigation reserves. Management has
      consistently applied the same critical accounting policies and estimates which
      are fully described in our Annual Report on Form 10-K for the year ended
      December 31, 2007.





We
      derive
      revenue from the licensing of software platforms along with the sale of
      associated application development services and maintenance, consulting, and
      hosting services and subscriptions. The arrangement may include delivery in
      multiple-element arrangements if the customer purchases a combination of
      products and/or services. We use the residual method pursuant to American
      Institute of Certified Public Accountants Statement of Position 97-2, *Software
      Revenue Recognition* ,
      or SOP
      97-2, which allows us to recognize revenue for a delivered element when such
      element has vendor specific objective evidence, or VSOE, of the fair value
      of
      the delivered element. If we cannot determine or maintain VSOE for an element,
      it could impact revenues as all or a portion of the revenue from the
      multiple-element arrangement may need to be deferred.





If
      multiple-element arrangements involve significant development, modification,
      or
      customization or if we determine that certain elements are essential to the
      functionality of other elements within the arrangement, we defer revenue until
      we provide all elements necessary to the functionality 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 our management.




20





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





1.
            persuasive
                evidence of an arrangement exists





2.
            delivery
                has occurred





3.
            the
                fee is fixed or determinable





4.
            collectibility
                is probable





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





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





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





We
      are
      currently facing legal actions from stockholders that relate to the charges
      filed against our former Chief Executive Officer described in Part I, Item
      3,
“Legal Proceedings,” in our Annual Report on Form 10-K for the year ended
      December 31, 2007. At this time, we are not able to determine the likely outcome
      of our currently pending legal matters, nor can we estimate our potential
      financial exposure. Management has made an initial estimate based upon its
      knowledge, experience, and input from legal counsel, and we have accrued
      approximately $137,500 of legal reserves. Such reserves will be adjusted in
      future periods as more information becomes available.





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





Total
      revenues were $1,726,000 for the second quarter of 2008 compared to $1,204,000
      for the second quarter of 2007, representing an increase of $522,000, or 43%.
      Gross profit increased $407,000, or 37%, to $1,499,000 from $1,092,000.
      Operating expenses increased $413,000, or 19%, to $2,624,000 from $2,211,000.
      Net loss grew to $1,302,000 from $1,215,000, an increase of $87,000, or 7%.




21
 
  The following table shows our consolidated statements
        of
        operations data expressed as a percentage of revenue for the periods
        indicated:


**Three
                  Months Ended**
                **June
                  30,**
                **2008**
              
              **Three
                  Months Ended**
                **June
                  30,**
                **2007**REVENUES:Subscription
                  Fees
              
              
              44
              %
              
              49
              %Professional
                  Service Fees
              
              
              55
              %
              
              26
              %License
                  Fees
              
              
              0
              %
              
              23
              %Other
                  Revenues
              
              
              1
              %
              
              2
              %Total
                  Revenues
              
              
              100
              %
              
              100
              %COST
                  OF REVENUES
              
              
              13
              %
              
              9
              %GROSS
                  PROFIT
              
              
              87
              %
              
              91
              %OPERATING
                  EXPENSES:General
                  and Administrative
              
              
              65
              %
              
              87
              %Sales
                  and Marketing
              
              
              44
              %
              
              39
              %Research
                  and Development
              
              
              43
              %
              
              57
              %Total
                  Operating Expenses
              
              
              152
              %
              
              183
              %LOSS
                  FROM OPERATIONS
              
              
              (65
              %)
              
              (92
              %)OTHER
                  INCOME (EXPENSE):Interest
                  Income (Expense), Net
              
              
              (11
              %)
              
              (11
              %)Other
                  Income
              
              
              1
              %
              
              3
              %Total
                  Other Income (Expense)
              
              
              (10
              %)
              
              (8
              %)NET
                  INCOME (LOSS)
              
              
              (75
              %)
              
              (100
              %)




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





**Revenue.** Total
      revenues were $1,726,000 for the second quarter of 2008 compared to $1,204,000
      for the second quarter of 2007 representing an increase of $522,000, or 43%.
      This overall increase in revenues was primarily attributable to an increase
      in
      revenue from professional service fees.





Professional
      service fees increased $636,000, or 200%, from the second quarter of 2007 to
      the
      second quarter of 2008. The growth in professional service fees reflects both
      an
      increase by adding a new customer as well as on-going monthly professional
      service fees to existing customers. Because new customers typically contract
      for
      significant upfront professional services, professional service fees generally
      increase in advance of the associated subscription revenues. Professional
      service fees accounted for approximately 55% of second quarter 2008 revenues
      as
      compared to approximately 26% for second quarter 2007. Management expects that
      professional service fees will continue to represent a greater portion of total
      revenues for fiscal 2008 as compared to fiscal 2007.





Subscription
      revenues increased $170,000, or 29%, to $747,000 for the second quarter of
      2008
      from $577,000 for the second quarter of 2007. This increase was primarily due
      to
      new partners that were added during the second half of 2007.





License
      fee revenue decreased from $280,000 in the second quarter of 2007 to $4,000
      for
      the second quarter of 2008. The 2007 ****** license
      revenue relates to a single perpetual license issued during the second quarter
      of 2007.





Other
      revenue totaled $21,000 for the second quarter of 2008 as compared to
      $29,000 ****** for
      the
      same period in 2007. This revenue is generated from non-core activities. We
      expect these revenue streams to continue to be insignificant in the future
      as we
      continue our strategy of focusing on growth of our subscription and license
      revenues.




22




**Cost
      of Revenues**





Cost
      of
      revenues increased $115,000, or 103%, to $226,000 in the second quarter of
      2008
      from $111,000 in the second quarter of 2007, primarily as a result of hosting,
      call center costs, and other fees associated with our increased subscription
      customer base.





**Operating
      Expenses**





Operating
      expenses increased $413,000, or 19%, to $2,624,000 for the second quarter of
      2008 from $2,211,000 during the second quarter of 2007. This increase was due
      to
      increases in general and administrative, sales and marketing, and development
      expenses of approximately 7%, 59%, and 9%, respectively.




*General
      and Administrative* -
      General
      and administrative expenses increased by $75,000, or 7%, to $1,126,000 for
      the
      second quarter of 2008 from $1,051,000 in the same quarter of 2007. The increase
      in the 2008 period is primarily attributable to increases in legal and
      professional fees, contract labor fees and recruiting costs associated with
      our
      search for a new Chief Financial Officer, and accruals for ****** taxes
      associated with the vesting of restricted stock awards. Following the
      resignation of our former Chief Financial Officer in the first quarter of 2008,
      we engaged a contract Interim Chief Financial Officer and initiated a search
      for
      a new full-time Chief Financial Officer resulting in a $30,000 increase in
      recruiting fees. During 2007, we began granting restricted stock, but failed
      to
      report certain taxes in connection with the vesting of the restricted stock.
      We
      accrued $55,000 during the second quarter of 2008 to cover the estimated tax
      obligations and fees. We are self-reporting to the Internal Revenue Service
      regarding this matter and are implementing procedures to ensure full tax
      compliance going forward. These increases were partially offset by a $134,000
      reduction in stock-based compensation expense resulting from our decision in
      June 2007 to limit future stock option grants.





*Sales
      and Marketing* -
      Sales
      and marketing expense increased to $753,000 in the second quarter of 2008 from
      $474,000 in the second quarter of 2007, an increase of $279,000, or
      59%. ****** This
      increase is primarily attributable to revenue sharing arrangements related
      to
      subscription customers added during the last half of 2007.





*Research
      and Development* -
      Research and development expense increased to $746,000 in the second quarter
      of
      2008 from $686,000 in the second quarter of 2007, an increase of approximately
      $60,000, or 9%. This increase primarily is due to an $18,000 increase in
      development wages (net of labor costs included in costs in excess of billings
      on
      our balance sheet) as we added and trained approximately 11 new ****** employees
      in North Carolina in preparation for the restructuring of our Michigan
      operations in July 2008 (see “Recent Developments” below), a $23,000 increase in
      travel associated with training new personnel, and a $17,000 increase in
      professional development expense. These increases were partially offset by
      a
      $9,000 decrease in outside consulting fees. We expect research and development
      expenses to decrease in the third quarter of 2008 as a result of the Michigan
      restructuring, including the elimination of 11 Michigan development
      positions.





**Other
      Income (Expense)**





We
      incurred net interest expense of $191,000 during the second quarter of 2008
      compared to net interest expense of $127,000 during the comparable 2007 quarter.
      Interest expense totaled $191,000 and $181,000 during the second quarters of
      2008 and 2007, respectively, while interest income decreased from $54,000 in
      the
      second quarter of 2007 to $0 in the second quarter of 2008. The second quarter
      2007 interest income was higher due to the interest earned on the cash proceeds
      of the February 2007 private placement described in Note 5, “Stockholders’
Equity,” to the consolidated financial statements in this report.




23





**Overview
      of Results of Operations for the Six Months Ended June 30, 2008 and June 30,
      2007**





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




**Six
                Months Ended**
              **June
                30,**
              **2008**
            
            **Six
                Months Ended**
              **June
                30,**
              **2007**REVENUES:Subscription
                Fees
            
            
            47
            %
            
            57
            %Professional
                Service Fees
            
            
            48
            %
            
            28
            %License
                Fees
            
            
            3
            %
            
            13
            %Other
                Revenues
            
            
            2
            %
            
            2
            %Total
                Revenues
            
            
            100
            %
            
            100
            %COST
                OF REVENUES
            
            
            13
            %
            
            9
            %GROSS
                PROFIT
            
            
            87
            %
            
            91
            %OPERATING
                EXPENSES:General
                and Administrative
            
            
            79
            %
            
            101
            %Sales
                and Marketing
            
            
            45
            %
            
            44
            %Development
            
            
            51
            %
            
            59
            %Total
                Operating Expenses
            
            
            175
            %
            
            204
            %LOSS
                FROM OPERATIONS
            
            
            (88
            %)
            
            (113
            %)OTHER
                INCOME (EXPENSE):Interest
                Income (Expense), Net
            
            
            (12
            %)
            
            (12
            %)Other
                Income
            
            
            1
            %
            
            6
            %Total
                Other Income (Expense)
            
            
            (11
            %)
            
            (6
            %)NET
                INCOME (Loss)
            
            
            (99
            %)
            
            (119
            %)





**Comparison
      of the Results of Operations for the Six Months Ended June 30, 2008 and June
      30,
      2007**





Total
      revenues increased by $1,003,000, or 47%, to $3,149,000 for the first half
      of
      2008 compared to $2,146,000 for the first half of 2007. Gross profit increased
      $778,000, or 40%, to $2,736,000 from $1,958,000. Operating expenses increased
      $1,145,000, or 26%, to $5,515,000 from $4,370,000. Net loss grew to $3,133,000
      from $2,525,000, an increase of $608,000, or 24%.





**Revenues**





Revenues
      totaled $3,149,000 for the first half of 2008 compared to $2,146,000 for the
      first half of 2007, representing an increase of $1,003,000, or 47%. This
      increase is attributable to increases in professional service fees and
      subscription revenues totaling $902,000 and $280,000, respectively.





Professional
      service fees increased $902,000, or 149%, to $1,509,000 for the first half
      of
      2008 from $606,000 for the first half of 2007. This increase was due to existing
      customers requesting additional consulting services for their web initiatives.
      Professional service fees accounted for approximately 48% of revenue for the
      first half of 2008 as compared to approximately 28% for the first half of 2007.
      Management expects that professional service fees will continue to represent
      a
      greater portion of total revenues for fiscal 2008 as compared to fiscal
      2007.





Subscription
      revenues increased $280,000, or 23%, to $1,490,000 for the first six months
      of
      2008 from $1,210,000 for the first six months of 2007. This increase was due
      to
      new partnerships under which we began recognizing revenue in the second half
      of
      2007.




24





License
      fees totaled $104,000 during the first half of 2008 compared to $280,000 for
      the
      same period in 2007. The 2008 revenue primarily related to a single license
      agreement signed during 2007 under which $100,000 of the fee was collected
      during the first quarter of 2008. This revenue was deferred at December 31,
      2007
      in accordance with the provisions of SOP 97-2. The 2007 license revenue related
      to a single perpetual license agreement entered into during the second quarter
      of 2007.





Other
      revenues totaled $46,000 for the first half of 2008 and $50,000 for the
      first half of 2007.




**Cost
      of Revenues**





Cost
      of
      revenues increased $225,000, or 120%, to $413,000 in the first six months of
      2008 from $188,000 in the first six months of 2007. This increase was primarily
      a result of a $65,000 increase in hosting costs related to hosting for
      additional customers, an increase in personnel costs of approximately $90,000
      related to the addition of call center staff during the second half of 2007,
      and
      a $31,000 increase in other fees associated with our increased subscription
      customer base.





**Operating
      Expenses**





Operating
      expenses increased $1,145,000, or 26%, to $5,515,000 for the first half of
      2008
      from $4,370,000 during the first half of 2007. This increase is due to an
      increase in general and administrative expenses of approximately $318,000,
      an
      increase in sales and marketing expense of approximately $484,000, and an
      increase in research and development expenses of approximately
      $344,000.




*General
      and Administrative* -
      General and administrative expenses increased by $318,000, or 15%,
      to $2,482,000 for the first half of 2008 from $2,164,000 for the first half
      of 2007. This increase is primarily attributable to increases in legal and
      professional fees, contract labor fees, and recruiting costs associated with
      our
      search for a new Chief Financial Officer, and accruals for ****** certain
      taxes associated with the vesting of restricted stock awards. Legal and
      professional fees increased $221,000 as we performed a review of our corporate
      and customer agreements, strengthened our controls and review procedures related
      to the legal function, and incurred fees in connection with the legal
      proceedings brought during the third quarter of 2007 against us, our former
      Chief Executive Officer, and a former employee. ****** Additionally,
      during the first quarter of 2008, we engaged a contract Interim Chief Financial
      Officer and initiated a search for a new full-time Chief Financial Officer
      resulting in a $30,000 increase in recruiting fees. During 2007, we began
      granting restricted stock, but failed to report certain taxes in connection
      with
      the vesting of restricted stock. We accrued $55,000 during the second quarter
      of
      2008 to cover the estimated tax obligations and fees. We are self-reporting
      to
      the Internal Revenue Service regarding this matter and are implementing
      procedures to ensure full tax compliance going forward. These increases were
      partially offset by a $120,000 reduction in stock-based compensation expense
      resulting from our 2007 decision to limit future stock option grants.





*Sales
      and Marketing* - Sales
      and marketing expense increased to $1,427,000 in the first half of 2008 from
      $943,000 in the first half of 2007, an increase of $484,000, or 51%. ****** This
      increase was primarily attributable to expense associated with revenue sharing
      arrangements, which increased by $338,000 from the first half of 2007, and
      a
      $106,000 increase in personnel expenses.





*Research
      and Development* -
      Research and development expense increased to $1,606,000 in the first six months
      of 2008 from $1,263,000 in the first six months of 2007, an increase of
      approximately $343,000, or 27%. This increase is due primarily to increased
      personnel expenses as we added research and development personnel during the
      last quarter of 2007 and first half of 2008 to enhance and customize our
      platforms and applications and launch additional private label
      sites.





**Other
      Income (Expense)**





We
      incurred net interest expense of $369,000 during the first half of 2008 as
      compared to $262,000 during the first half of 2007. Interest expense increased
      as a direct result of increased indebtedness under lines of credit and $3.3
      million of secured subordinated convertible notes issued in November 2007.
      The
      convertible notes bear interest at 8% payable in quarterly installments that
      commenced on February 14, 2008. Interest income totaled $85,000 for the first
      half of 2007 as compared to $14,000 for the first half of 2008. The decrease
      in
      interest income is due to lower cash balances. The first half 2007 interest
      income was attributable to the interest earned on the cash proceeds of the
      February 2007 private placement described in Note 5, “Stockholders’ Equity,” to
      the consolidated financial statements in this report.




25





During
      the first half of 2007, we recognized $114,000 of other income, including an
      $86,000 adjustment to registration rights penalties previously expensed during
      2006.





**Provision
      for Income Taxes**





We
      have
      not recorded a provision for income tax expense because we have been generating
      net losses. Furthermore, we have not recorded an income tax benefit for the
      second quarter of 2008 primarily due to continued substantial uncertainty
      regarding our ability to realize our deferred tax assets. Based upon available
      objective evidence, there has been sufficient uncertainty regarding the ability
      to realize our deferred tax assets, which warrants a full valuation allowance
      in
      our financial statements. We have approximately $46,000,000 in net operating
      loss carryforwards, which may be utilized to offset future taxable
      income.





**Liquidity
      and Capital Resources**





At
      June
      30, 2008, our principal sources of liquidity were cash and cash equivalents
      totaling $183,000 and current accounts receivable of $742,000. As of August
      8,
      2008, our principal sources of liquidity were cash and cash equivalents totaling
      approximately $130,000 and accounts receivable of approximately $651,000. As
      of
      June 30, 2008, we had drawn approximately $1.84 million on our $2.47 million
      line of credit with Paragon Commercial Bank (“Paragon”), leaving approximately
      $630,000 available under the line of credit for our operations. As of August
      8,
      2008, we had drawn approximately $2.26 million on the Paragon line of credit,
      leaving approximately $210,000 available under the line of credit for our
      operations, and we expect to continue to draw down on this line of credit as
      needed for working capital purposes. This line of credit expires in February
      2009. As of August 8, 2008, we also had the ability to call up to approximately
      $5.2 million of additional funding from our convertible noteholders. Subsequent
      changes in the convertible notes are described below under “Recent
      Developments.”





During
      the quarter ended June 30, 2008, our working capital deficit increased by
      approximately $2,314,000 to approximately $1,427,000. This compared to a working
      capital surplus of $887,000 at December 31, 2007. As described more fully below,
      the working capital deficit at June 30, 2008 is primarily attributable to
      negative cash flows from operations, including a $247,000 increase in accounts
      receivable during the first half of 2008.





**Cash
      Flow from Operations** .
      Cash
      flows used in operations for the six months ended June 30, 2008 totaled
      $2,840,000, up from $2,182,000 for the six months ended June 30, 2007. This
      increase is primarily due to paying down outstanding trade accounts payable,
      an
      increase in outstanding accounts receivable, and a general increase in cash
      operating costs.





**Cash
      Flow from Investing Activities** .
      For the
      six months ended June 30, 2008, we utilized approximately $49,000 in investing
      activities compared to $54,000 for the same period in 2007, substantially all
      of
      which related to the acquisition of equipment and furniture.





**Cash
      Flow from Financing Activity** .
      For the
      six months ended June 30, 2008, we utilized approximately $401,000 net cash
      in
      financing activities principally to retire a line of credit as discussed below.
      For the six months ended June 30, 2007, we generated a total of $5,538,000
      net
      cash from our financing activities through both equity and debt financing,
      as
      described below.





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





*Debt
      Financing.* On
      February 15, 2008, we repaid the full outstanding principal balance of
      $2,052,000 and accrued interest of $2,890 outstanding under our revolving credit
      arrangement with Wachovia Bank, NA, or Wachovia. The line of credit advanced
      by
      Wachovia was $2.5 million to be used for general working capital purposes.
      Any
      advances made on the line of credit were to be paid off no later than August
      1,
      2008. The line of credit was secured by our deposit account at Wachovia and
      the
      irrevocable standby letter of credit issued by HSBC Private Bank (Suisse) SA,
      or
      HSBC, with Atlas Capital, SA, or Atlas, one of our current stockholders, both
      of
      which were released by Wachovia.




26





On
      February 20, 2008, we entered into a revolving credit arrangement with Paragon
      that is subject to annual renewal subject to mutual approval. The line of credit
      advanced by Paragon is $2.47 million and can be used for general working
      capital. Any advances made on the line of credit must be paid off no later
      than
      February 19, 2009, with monthly payments being applied first to accrued interest
      and then to principal. The interest shall accrue on the unpaid principal balance
      at the Wall Street Journal’s published prime rate minus one half percent. As of
      June 30, 2008, the line of credit was secured by an irrevocable standby letter
      of credit in the amount of $2.5 million issued by HSBC with Atlas as account
      party. We also have agreed with Atlas that in the event of our default in the
      repayment of the line of credit that results in the letter of credit being
      drawn, we will reimburse Atlas any sums that Atlas is required to pay under
      such
      letter of credit. At our sole discretion, these payments may be made in cash
      or
      by issuing shares of our common stock at a set per share price of $2.50.





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





We
      have
      not yet achieved positive cash flows from operations, and our main sources
      of
      funds for our operations are the sale of securities in private placements,
      the
      sale of additional convertible notes, and bank lines of credit. We must continue
      to rely on these sources until we are able to generate sufficient revenue to
      fund our operations. We believe that anticipated cash flows from operations,
      funds available from our existing line of credit, and additional issuances
      of
      notes, together with cash on hand, will provide sufficient funds to finance
      our
      operations at least for the next 12 to 18 months, depending on our ability
      to
      achieve strategic goals outlined in our annual operating budget approved by
      our
      Board of Directors. Changes in our operating plans, lower than anticipated
      sales, increased expenses, or other events may cause us to seek additional
      equity or debt financing in future periods. There can be no guarantee that
      financing will be available on acceptable terms or at all. Additional equity
      financing could be dilutive to the holders of our common stock, and additional
      debt financing, if available, could impose greater cash payment obligations
      and
      more covenants and operating restrictions.





**Recent
      Developments**





*Restructuring
      of Michigan Operations* .
      On July
      1, 2008, our management initiated a restructuring program that is aimed at
      reducing operating, general and administrative expenses in fiscal 2008 by
      consolidating significant operations in our location in Durham, North Carolina
      near Research Triangle Park. The plan includes severance of certain of our
      employees located in Grand Rapids, Michigan.





We
      initiated this program as part of our ongoing efforts to realign certain
      production and development functions and eliminate redundant administrative
      functions as well as proactively and prudently manage operating, general and
      administrative costs. We expect to record a one-time restructuring charge of
      approximately $53,000 during the third quarter of fiscal 2008, primarily as
      a
      result of certain one-time termination benefits that will be provided in
      connection with the plan as well as costs associated with the continued
      employment of three employees in Grand Rapids. In addition, we have initiated
      an
      impairment evaluation of goodwill and intangible assets related to the Grand
      Rapids operations. We have not completed this evaluation and therefore have
      not
      determined whether any portion of our recorded goodwill and/or intangible assets
      balance is impaired.





*Suit
      Against Former Employee* . On
      July
      14, 2008, we filed a civil action against a former employee in the General
      Court
      of Justice, Superior Court Division, Durham County, North Carolina. The
      complaint alleges that the former employee embezzled funds from us in the amount
      of $105,600 and asserts claims for conversion and unfair trade practices. The
      lawsuit seeks recovery for the embezzled funds, plus punitive damages or treble
      damages, interest, and attorneys’ fees.




27





*Appointment
      of Chief Financial Officer* .
      On July
      15, 2008, our Board of Directors unanimously appointed Timothy L. Krist as
      our
      Chief Financial Officer. Effective July 9, 2008, we notified George Cahill,
      our
      Interim Chief Financial Officer, that pursuant to Paragraph 3 of our Consulting
      Agreement with Mr. Cahill dated April 22, 2008, we were exercising our right
      to
      terminate his consulting services. As previously reported, Mr. Cahill was
      serving in this position on a temporary basis during our search for a permanent
      Chief Financial Officer.





*Convertible
      Note Financing.* As
      more
      fully described elsewhere in this report, on August 12, 2008 we exercised our
      option to sell $1.5 million aggregate principal amount of additional secured
      subordinated convertible notes due November 14, 2010 to two of our current
      noteholders. We are obligated to pay interest on the additional notes at an
      annualized rate of 8% payable in quarterly installments commencing on November
      12, 2008. We are not permitted to prepay the notes without approval of the
      holders of at least a majority of the aggregate principal amount of the notes
      then outstanding. We plan to use the proceeds to meet ongoing working capital
      and capital spending requirements.





In
      connection with the sale of the additional notes, the noteholders holding a
      majority of the aggregate principal amount of the notes outstanding agreed
      to
      increase the aggregate principal amount of secured subordinated convertible
      notes that they are committed to purchase from $8.5 million to $15.3 million,
      of
      which $4.8 million is currently outstanding.





*Insurance
      Reimbursement* .
      On
      August 7, 2008, we and our prior insurance carrier agreed that the carrier
      would
      reimburse us $300,000 for previously disputed legal expenses primarily
      related to our previously disclosed SEC matters. The reimbursement covered
      all
      disputed company expenses prior to September 11, 2007 as well as certain
      enumerated invoices in dispute for the balance of 2007.





**Item
      3.**    **Quantitative
      and Qualitative Disclosures About Market Risk**




Not
      applicable.





**Item
      4.**   **Controls
      and Procedures**





Not
      applicable.





**Item
              4T.**
            **Controls
                and Procedures**





We
      maintain disclosure controls and procedures (as defined in Rules 13a-15(e)
      and
      15d-15(e) under the Exchange Act) that are designed to provide reasonable
      assurances that information required to be disclosed by us in the reports that
      we file or submit under the Exchange Act is recorded, processed, summarized
      and
      reported, within the time periods specified in the Securities and Exchange
      Commission’s, or the SEC’s, rules and forms, and that such information is
      accumulated and communicated to management, including our Chief Executive
      Officer and Chief Financial Officer, as appropriate, to allow timely decisions
      regarding required disclosure. In designing and evaluating the disclosure
      controls and procedures, management recognized that disclosure controls and
      procedures, no matter how well designed and operated, can provide only
      reasonable assurances of achieving the desired control objectives, as ours
      are
      designed to do, and management necessarily was required to apply its judgment
      in
      evaluating the cost-benefit relationship of possible controls and
      procedures.





Our
      management, with the participation of our Chief Executive Officer and Chief
      Financial Officer, has evaluated the effectiveness of our disclosure controls
      and procedures as of the end of the period covered by this Quarterly Report
      on
      Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief
      Financial Officer concluded that, as of the end of the period covered by this
      Quarterly Report on Form 10-Q, our disclosure controls and procedures were
      effective to ensure that information required to be disclosed by us in the
      reports we file under the Exchange Act is recorded, processed, summarized and
      reported within the time periods specified in the SEC’s rules and forms.




28





We
      have
      made the following changes to our internal controls over financial reporting
      during the second quarter of fiscal 2008:





·
            improved
                the reconciliation process for determining the weighted average earning
                per share and number of outstanding shares of common
                stock;





·
            reviewed
                and modified the process for documenting outstanding equity awards
                and
                releasing restrictions on restricted stock;
                and





·
            engaged
                an outside accounting consultant to assist us with improving our
                reconciliation and month end closing
                processes.





Other
      than as described above, there have been no changes
      to our internal controls over financial reporting during the second quarter
      of
      fiscal 2008 that have materially affected, or are reasonably likely to
      materially affect, our internal control over financial reporting.





During
      the third quarter of 2008, we are working to implement internal control
      procedures to address our failure to report certain taxes associated with the
      vesting of restricted stock awards and the recently discovered employee
      embezzlement of our funds. As
      part
      of our ongoing efforts to improve our internal control over financial reporting,
      our new Chief Financial Officer is evaluating certain financial and accounting
      functions, and we expect to make several additional changes to our internal
      control over financial reporting during the remainder of fiscal 2008.





**PART
      II - OTHER INFORMATION**





**Item
      1.**   **Legal
      Proceedings**





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





On
      July
      14, 2008, we filed a civil action against a former employee in the General
      Court
      of Justice, Superior Court Division, Durham County, North Carolina. The
      complaint alleges that the former employee embezzled funds from us in the amount
      of $105,600 and asserts claims for conversion and unfair trade practices. The
      lawsuit seeks recovery for the embezzled funds, plus punitive damages or treble
      damages, interest, and attorneys’ fees.





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





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




29




**Item
              1A.**
            **Risk
                Factors**





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





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





We
      have
      had recurring losses from operations and continue to have negative cash flows.
      If we do not become cash flow positive through additional financing or growth,
      we may have to cease operations and liquidate our business. Our
      working capital, including our line of credit with Paragon, February 2007 equity
      financing transaction, and convertible note financings, should fund our
      operations for the next 12 to 18 months. As of August 8, 2008, we have
      approximately $213,000 available on our revolving line of credit and
      approximately $5.2 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, the
      charges filed against a former officer and a former employee filed by the SEC
      and the United States Attorney General, and the pending shareholder class action
      lawsuit may require us to seek additional funding sooner than we expect. If
      we
      fail to raise sufficient financing, we will not be able to implement our
      business plan and may not be able to sustain our business.





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




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





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





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




30





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





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





The
      lawsuit filed against us by the SEC, the SEC and criminal actions filed against
      a former officer and a former employee, the class action lawsuit filed against
      us and certain current and former officers, directors, and employees, and the
      lawsuit filed by a former executive officer against us, all as described in
      our
      Annual Report on Form 10-K for the year ended December 31, 2007, have harmed
      our
      business in many ways, and may cause further harm in the future. Since the
      initiation of these actions, our ability to raise financing from new investors
      on favorable terms has suffered due to the lack of liquidity of our stock,
      the
      questions raised by these actions, and the resulting drop in the price of our
      common stock. As a result, we may not raise sufficient financing, if necessary,
      in the future.





Legal
      and
      other fees related to these actions have also reduced our available cash. We
      make no assurance that we will not continue to experience additional harm as
      a
      result of these matters. The time spent by our management team and directors
      dealing with issues related to these actions detracts from the time they spend
      on our operations, including strategy development and implementation. These
      actions also have harmed our reputation in the business community, jeopardized
      our relationships with vendors and customers, and decreased our ability to
      attract qualified personnel, especially given the media coverage of these
      events.





In
      addition, we face uncertainty regarding amounts that we may have to pay as
      indemnification to certain current and former officers, directors, and employees
      under our Bylaws and Delaware law with respect to these actions, and we may
      not
      recover all of these amounts from our directors and officers liability insurance
      policy carrier. Our
      Bylaws and Delaware law generally require us to indemnify, and in certain
      circumstances advance legal expenses to, current and former officers and
      directors against claims arising out of such person’s status or activities as
      our officer or director, unless such person (i) did not act in good faith and
      in
      a manner the person reasonably believed to be in or not opposed to our best
      interests or (ii) had reasonable cause to believe his conduct was unlawful.
      As
      of August 8, 2008, there are SEC and criminal actions pending against a former
      executive officer and a former employee who have requested that we indemnify
      them and advance expenses incurred by them in the defense of those actions.
      Also, a stockholder class action lawsuit has been filed against us and certain
      of our current ****** and
      former officers, directors, and employees. The SEC, criminal, and stockholder
      actions are more fully described in Part I, Item 3, “Legal Proceedings,” in our
      Annual Report on Form 10-K for the year ended December 31, 2007.





Generally,
      we are required to advance defense expenses prior to any final adjudication
      of
      an individual’s culpability. The expense of indemnifying our current and former
      directors, officers, and employees for their defense or related expenses in
      connection with the current actions may be significant. Our Bylaws require
      that
      any director, officer, employee, or agent requesting advancement of expenses
      enter into an undertaking with us to repay any amounts advanced unless it is
      ultimately determined that such person is entitled to be indemnified for the
      expenses incurred. This provides us with an opportunity, depending upon the
      final outcome of the matters and the Board’s subsequent determination of such
      person’s right to indemnity, to seek to recover amounts advanced by us. However,
      we may not be able to recover any amounts advanced if the person to whom the
      advancement was made lacks the financial resources to repay the amounts that
      have been advanced. If we are unable to recover the amounts advanced, or can
      do
      so only at great expense, our operations may be substantially harmed as a result
      of loss of capital.




31





Although
      we have purchased insurance that may cover these obligations, we can offer
      no
      assurances that all of the amounts that may be expended by us will be recovered
      under our insurance policy. It is possible that we may have an obligation to
      indemnify our current and former officers and directors under the terms of
      our
      Bylaws and Delaware law, but that there may be insufficient coverage for these
      payments under the terms of our insurance policy. Therefore, we face the risk
      of
      making substantial payments related to the defense of these actions, which
      could
      significantly reduce amounts available to fund working capital, capital
      expenditures, and other general corporate objectives.





In
      addition, our insurance policy provides that, under certain conditions, our
      insurer may have the right to seek recovery of any amounts it paid to the
      individual insureds or us. As of August 8, 2008, we do not know and can offer
      no
      assurances about whether these conditions will apply or whether the insurance
      carrier will change its position regarding coverage related to the current
      actions. Therefore, we can offer no assurances that our insurer will not seek
      to
      recover any amounts paid under its policy from the individual insureds or us.
      If
      such recovery is sought, then we may have to expend considerable financial
      resources in defending and potentially settling or otherwise resolving such
      a
      claim, which could substantially reduce the amount of capital available to
      fund
      our operations.





Finally,
      if our directors and officers liability insurance premiums increase as a result
      of the current actions, our financial results may be materially harmed in future
      periods. If we are unable to obtain coverage due to prohibitively expensive
      premiums, we would have more difficulty in retaining and attracting officers
      and
      directors and would be required to self-fund any potential future liabilities
      ordinarily mitigated by directors and officers liability insurance.





**Our
      executive management team is critical to the execution of our business plan
      and
      the loss of their services could severely impact negatively on our business.**





Our
      executive management team has undergone significant changes during late 2007
      and
      the first half of 2008. Our success depends significantly on the continued
      services of our executive management personnel and attracting additional
      qualified personnel. Losing any of our officers could seriously harm our
      business. Competition for executives is intense. Although we have resolved
      the
      SEC charges filed against us, we may not be able to attract highly qualified
      candidates to serve on our executive management team. If we had to replace
      any
      of our officers, we would not be able to replace the significant amount of
      knowledge that they may have about our operations. If we cannot attract and
      retain qualified personnel and integrate new members of our executive management
      team effectively into our business, then our business and financial results
      may
      suffer. In addition, all of our executive team work at the same location, which
      could make us vulnerable to loss of our entire management team in the event
      of a
      natural or other disaster. We do not maintain key man insurance policies on
      any
      of our employees.





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





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





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





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





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




32





For
      fiscal 2009, w e
      will be
      required to comply with the requirements of Section 404 of Sarbanes-Oxley
      involving our independent accountant’s audit of our internal control over
      financial reporting. To comply with these requirements, we are evaluating and
      testing our internal controls, and where necessary, taking remedial actions,
      to
      allow our independent auditors to attest to our internal control over financial
      reporting. As a result, we have incurred and will continue to incur expenses
      and
      diversion of management’s time and attention from the daily operations of the
      business, which may increase our operating expenses and impair our ability
      to
      achieve profitability.





We
      have
      identified several significant deficiencies in our internal
      control over
      financial reporting. We are working to remediate these identified significant
      deficiencies, and we cannot give any assurances that all significant
      deficiencies or material weaknesses have been identified or that additional
      significant deficiencies or material weaknesses will not be identified in the
      future in connection with our compliance with the provisions of Section 404
      of
      Sarbanes-Oxley. The existence of one or more material weaknesses would preclude
      a conclusion by management that we maintained effective internal control over
      financial reporting.





Our
      former Chief Financial Officer resigned at the end of the first quarter of
      2008,
      resulting in our loss of his financial expertise and knowledge of our history
      and past transactions. We engaged an outside accounting consultant and an
      Interim Chief Financial Officer, each with a level of accounting knowledge,
      experience, and training in the application of generally accepted accounting
      principles commensurate with our financial reporting requirements to assist
      us
      during the transition period between permanent Chief Financial Officers. With
      their assistance, we have begun the process of restructuring our financial
      and
      accounting functions to address concerns regarding segregation of duties and
      to
      strengthen other areas in need of improvement. We appointed a new Chief
      Financial Officer on July 15, 2008.





There
      can
      be no assurance that we will be able to maintain our schedule to complete all
      assessment and testing of our internal controls in a timely manner. Further,
      we
      cannot be certain that our testing
      of internal controls and
      resulting remediation actions will yield adequate internal
      control over
      financial reporting as required by Section 404 of Sarbanes-Oxley. If we are
      not
      able to implement the requirements of Section 404 in a timely manner or with
      adequate compliance, there could be an adverse reaction in the financial markets
      due to a loss of confidence in the reliability of our financial statements,
      which could adversely affect the market price of our common stock.





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





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





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





**Our
      failure to properly report certain taxes in connection with the vesting of
      restricted stock could result in tax penalties and interest from the Internal
      Revenue Service and state tax authorities.**





During
      2007, we began granting restricted stock, but failed to properly report certain
      taxes in connection with the vesting of restricted stock. We accrued $55,000
      during the second quarter of 2008 to cover the estimated tax obligations and
      fees. We are self-reporting to the Internal Revenue Service regarding this
      matter ****** and
      expect to pay penalties and interest to the Internal Revenue Service and state
      tax authorities in connection with these delinquent taxes. In addition, we
      are
      subject to a settlement offer in compromise order with the Internal Revenue
      Service regarding past tax obligations and could be subject to significant
      past
      penalties related to this order depending upon the Internal Revenue Service’s
      view of our approach to handling the current matter. Any such additional tax
      penalties could materially and adversely impact our financial condition and
      results of operations.




33





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





We
      may
      issue shares of our common stock in the future for a variety of reasons. For
      example, under the terms of our stock purchase warrant and agreement with Atlas,
      it may elect to purchase up to 444,444 shares of our common stock at $2.70
      per
      share upon termination of, or if we are in breach under the terms of, our line
      of credit with Paragon. In connection with our private financing in February
      2007, we issued warrants to the investors to purchase an additional 1,176,471
      shares of our common stock at $3.00 per share and a warrant to our placement
      agent in that transaction to purchase 35,000 shares of our common stock at
      $2.55
      per share. Upon maturity of their convertible notes, our noteholders may elect
      to convert all, a part of, or none of their notes into shares of our common
      stock at variable conversion prices. In addition, we may raise funds in the
      future by issuing additional shares of common stock or other
      securities.




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





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





Future
      sales of substantial amounts of our shares in the public market, or the
      appearance that a large number of our shares are available for sale, could
      adversely affect market prices prevailing from time to time and could impair
      our
      ability to raise capital through the sale of our securities. At August 8, 2008,
      18,325,606 shares of our common stock were issued and outstanding and a
      significant number of shares may be issued upon the exercise of outstanding
      options, warrants, and convertible notes.





Our
      stock
      historically has been very thinly traded. The average daily trading volume
      for
      our common stock between January 2008 and June 2008 was approximately 44,251
      shares per day. The number of shares that could be sold during this period
      was
      restrained by previous contractual and other legal limitations imposed on some
      of our shares that are no longer applicable. This means that market supply
      may
      increase more than market demand for our shares. Many companies experience
      a
      decrease in the market price of their shares when such events
      occur.





We
      cannot
      predict if future sales of our common stock, or the availability of our common
      stock held for sale, will materially and adversely affect the market price
      for
      our common stock or our ability to raise capital by offering equity or other
      securities. Our stock price may decline if the resale of shares under Rule
      144,
      in addition to the resale of registered shares, at any time in the future
      exceeds the market demand for our stock.





**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.




34





Further,
      securities class action litigation has often been brought against companies
      that
      experience periods of volatility in the market prices of their securities.
      A
      securities class action was filed against us in October 2007 as more fully
      described in our Annual Report on Form 10-K for the year ended December 31,
      2007. This securities class action litigation could result in substantial costs
      and a diversion of our management’s attention and resources. We may determine,
      like many defendants in such lawsuits, that it is in our best interest to settle
      the lawsuit, even if we believe that the plaintiffs’ claims have no merit, to
      avoid the cost and distraction of continued litigation. Any liability we incur
      in connection with this or any other potential lawsuit could materially harm
      our
      business and financial position and, even if we defend ourselves successfully,
      there is a risk that management’s distraction in dealing with this type of
      lawsuit could harm our results.





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





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





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





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





**If
      we fail to evaluate, implement, and integrate strategic opportunities
      successfully, our business may suffer.**





From
      time
      to time we evaluate strategic opportunities available to us for product,
      technology, or business acquisitions or dispositions. If we choose to make
      acquisitions or dispositions, we face certain risks, such as failure of an
      acquired business to meet our performance expectations, diversion of management
      attention, retention of existing customers of our current and acquired business,
      and difficulty in integrating or separating a business’s operations, personnel,
      and financial and operating systems. We may not be able to successfully address
      these risks or any other problems that arise from our previous or future
      acquisitions or dispositions. Any failure to successfully evaluate strategic
      opportunities and address risks or other problems that arise related to any
      acquisition or disposition could adversely affect our business, results of
      operations, and financial condition.





**Item
      4.**   **Submission
      of Matters to a Vote of Security Holders**





Our
      Annual Meeting of Stockholders was held on June 19, 2008. The following matters
      were submitted to a vote of the stockholders with the results shown
      below:




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





Name
            Votes
                For
            Votes
                Against
            Votes
                WithheldDoron
                Roethler
            11,286,688
            200
            497,279David
                E. Colburn
            11,298,888
            200
            485,079Thomas
                P. Furr
            11,298,688
            200
            485,279Shlomo
                Elia
            11,783,567
            200
            400C.
                James Meese, Jr.
            11,783,767
            200
            200Dror
                Zoreff
            11,783,567
            200
            400




35


(b)
      Ratification of the appointment of Sherb & Co., LLP as independent auditors
      for the fiscal year ended December 31, 2008.





Votes
                For
            Votes
                Against
            Abstained11,770,771
            13,396
            0





The
      matters listed above are described in detail in our definitive proxy statement
      dated April 23, 2008 for the Annual Meeting of Stockholders held on June 19,
      2008.





**Item
      5.**   **Other
      Information**





**Convertible
      Note Financing**





On
      August
      12, 2008, we exercised our option to sell $1.5 million aggregate principal
      amount of additional secured subordinated convertible notes due November 14,
      2010, or the additional notes, with substantially the same terms and conditions
      as the initial notes sold on November 14, 2007. For purposes of this discussion,
      the initial notes and the additional notes will be referred to collectively
      as
      the notes.





We
      are
      obligated to pay interest on the additional notes at an annualized rate of
      8%
      payable in quarterly installments commencing on November 12, 2008. We are not
      permitted to prepay the additional notes without approval of the holders of
      at
      least a majority of the principal amount of the notes then outstanding.





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





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


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





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




·
            $3.05;
                and


·
            the
                average of the closing bid and asked prices of shares of our common
                stock
                quoted in the Over-The-Counter Market Summary (or, if ours shares
                are
                traded on the Nasdaq Stock Market or another exchange, the closing
                price
                of shares of our common stock quoted on such exchange) averaged over
                five
                trading days prior to the closing date of the sale of the additional
                notes.





Upon
      the
      following events of default and at any time during the continuance of such
      an
      event of default, the noteholders have the right, with the consent of the agent
      appointed for such noteholders, to accelerate payment on their
      notes:





·
            failure
                to pay any amounts when due;


·
            non-performance
                of any material covenant that remains uncured for 15
                days;


·
            any
                of our representations and warranties prove to have been false or
                misleading in any material respect when
                made;


·
            one
                or more judgments, decrees, or orders (excluding settlement orders)
                for
                the payment of money in the aggregate of $1,000,000 or more is entered
                against us or a subsidiary and is not discharged or stayed for a
                period of
                60 days; or


·
            default
                by us or a subsidiary under any agreement related to indebtedness
                resulting in the acceleration of more than $500,000 of
                indebtedness.





In
      addition, payment of the notes will be automatically accelerated if we enter
      voluntary or involuntary bankruptcy or insolvency proceedings.




The
      notes
      are secured by a first-priority lien on all of our unencumbered assets.




36





The
      additional notes and the common stock into which they may be converted have
      not
      been registered under the Securities Act or the securities laws of any other
      jurisdiction. As a result, offers and sales of the additional notes were made
      pursuant to Regulation D of the Securities Act and only made to accredited
      investors that were our existing stockholders. The investors are (i) Atlas,
      which originally recommended Shlomo Elia, one of our directors, for appointment
      to the Board of Directors; and (ii) Crystal Management Ltd., which is owned
      by
      Doron Roethler, our Chairman of the Board of Directors and bond representative
      for the noteholders. Unless and until they are registered, the additional notes
      and the common stock into which they may be converted may not be offered or
      sold
      except pursuant to an exemption from, or in a transaction not subject to, the
      registration requirements of the Securities Act or applicable securities laws
      of
      other jurisdictions.





If
      notes
      are converted into our common stock and a demand for registration of the shares
      of common stock is made by a holder of a majority of the converted common stock,
      we have agreed, subject to certain limitations, to use our best efforts to
      file
      a registration statement with the SEC:





·
            within
                180 days of such demand if:


o
            we
                are eligible to use Form S-1,and


o
            the
                demand is made with respect to at least 40% of the converted common
                stock
                then outstanding (or a lesser percentage if the anticipated aggregate
                offering price, net of selling expenses, would exceed $5
                million);
                and


·
            within
                90 days of such demand if:


o
            we
                are eligible to use Form S-3, and


o
            the
                demand is made with respect to at least 30% of the converted common
                stock
                then outstanding and the anticipated aggregate offering price, net
                of
                selling expenses, would exceed $2
                million.





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





The
      noteholders have designated Doron Roethler, our Chairman of the Board of
      Directors, as bond representative to act as their agent. We have agreed that
      the
      bond representative and his representatives shall be granted access to our
      facilities and personnel during normal business hours, shall have the right
      to
      have his representative attend all meetings of our Board of Directors and its
      committees, and to receive all materials provided to the Board of Directors
      or
      any committee of the Board of Directors. We have agreed to pay all reasonable
      travel and lodging expenses of the bond representative related to his access
      to
      our facilities and attendance at Board of Directors meetings. In addition,
      so
      long as the notes are outstanding, we have agreed that we will not take any
      of
      the following actions without approval of the bond representative:





·
            make
                any loan or advance to, or own any stock or other securities of,
                any
                subsidiary or other corporation, partnership, or other entity unless
                it is
                wholly owned by us, except that we may own securities of 1-800-Pharmacy,
                Inc. pursuant to an agreement we have with it without obtaining the
                bond
                representative’s consent;





·
            make
                any loan or advance to any person, except advances and similar
                expenditures in the ordinary course of business or under the terms
                of an
                employee stock or option plan approved by our Board of Directors;





·
            guarantee
                any indebtedness except for our trade accounts or those of a subsidiary
                arising in the ordinary course of business;





·
            make
                any investment other than investments in prime commercial paper,
                money
                market funds, certificates of deposit in any United States bank having
                a
                net worth in excess of $100,000,000 or obligations issued or guaranteed
                by
                the United States of America, in each case having a maturity not
                in excess
                of two years;





·
            incur
                any aggregate indebtedness in excess of $25,000, other than trade
                credit
                incurred in the ordinary course of business;




37




·
            increase
                or approve the compensation of our named executive officers, including
                benefits, bonuses, and issuances of equity compensation;





·
            change
                our principal business, enter new lines of business, or exit the
                current
                line of business;





·
            sell,
                transfer, exclusively license, pledge, or encumber technology or
                intellectual property;





·
            create
                or authorize the creation of or issue any other security convertible
                into
                or exercisable for any equity security, other than issuances to employees
                pursuant to equity compensation plans approved by our Board of Directors;





·
            purchase
                or redeem or pay any dividend on any capital stock, other than stock
                repurchased from former employees or consultants in connection with
                the
                cessation of their employment/services, at the lower of fair market
                value
                or cost; or





·
            increase
                the number of shares authorized for issuance to officers, directors,
                employees, consultants, and advisors pursuant to equity incentive
                plans or
                arrangements.




We
      plan
      to use the proceeds to meet ongoing working capital and capital spending
      requirements.





In
      connection with the sale of the additional notes, the noteholders holding a
      majority of the aggregate principal amount of the notes outstanding agreed
      to
      increase the aggregate principal amount of secured subordinated convertible
      notes that they are committed to purchase from $8.5 million to $15.3 million,
      of
      which $4.8 million is currently outstanding.





**Item
      6.**   **Exhibits**





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








Exhibit
                No.
            Description10.1
            Consulting
                Agreement between the Company and George Cahill, effective April
                22, 2008
                (incorporated herein by reference to Exhibit 10.1 to our Current
                Report on
                Form 8-K, as filed with the SEC on April 23, 2008)31.1
            Certification
                of Principal Executive Officer Pursuant to Rule 13a-14(a) as Adopted
                Pursuant to Section 302 of the Sarbanes-Oxley Act of
                200231.2
            Certification
                of Principal Financial Officer Pursuant to Rule 13a-14(a) as Adopted
                Pursuant to Section 302 of the Sarbanes-Oxley Act of
                200232.1
            Certification
                of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350,
                as
                Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                This
                exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley
                Act of 2002 and shall not, except to the extent required by that
                Act, be
                deemed to be incorporated by reference into any document or filed
                herewith
                for the purposes of liability under the Securities Exchange Act of
                1934,
                as amended, or the Securities Act of 1933, as amended, as the case
                may
                be.32.2
            Certification
                of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350,
                as
                Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                This
                exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley
                Act of 2002 and shall not, except to the extent required by that
                Act, be
                deemed to be incorporated by reference into any document or filed
                herewith
                for the purposes of liability under the Securities Exchange Act of
                1934,
                as amended, or the Securities Act of 1933, as amended, as the case
                may
                be.




38




**SIGNATURES**





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




**Smart
                Online, Inc.**/s/
                David E. ColburnDavid
                E. ColburnDate:
                August 12, 2008
            Principal
                Executive Officer/s/
                Timothy L. KristTimothy
                L. KristPrincipal
                Financial Officer andDate:
                August 12, 2008
            Principal
                Accounting Officer






39







**EXHIBIT
      INDEX**





Exhibit
                No.
            Description10.1
            Consulting
                Agreement between the Company and George Cahill, effective April
                22, 2008
                (incorporated herein by reference to Exhibit 10.1 to our Current
                Report on
                Form 8-K, as filed with the SEC on April 23, 2008)31.1
            Certification
                of Principal Executive Officer Pursuant to Rule 13a-14(a) as Adopted
                Pursuant to Section 302 of the Sarbanes-Oxley Act of
                200231.2
            Certification
                of Principal Financial Officer Pursuant to Rule 13a-14(a) as Adopted
                Pursuant to Section 302 of the Sarbanes-Oxley Act of
                200232.1
            Certification
                of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350,
                as
                Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                This
                exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley
                Act of 2002 and shall not, except to the extent required by that
                Act, be
                deemed to be incorporated by reference into any document or filed
                herewith
                for the purposes of liability under the Securities Exchange Act of
                1934,
                as amended, or the Securities Act of 1933, as amended, as the case
                may
                be.32.2
            Certification
                of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350,
                as
                Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
                This
                exhibit is being furnished pursuant to Section 906 of the Sarbanes-Oxley
                Act of 2002 and shall not, except to the extent required by that
                Act, be
                deemed to be incorporated by reference into any document or filed
                herewith
                for the purposes of liability under the Securities Exchange Act of
                1934,
                as amended, or the Securities Act of 1933, as amended, as the case
                may
                be.




40