UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549










FORM 10-Q/A








(Mark
One)


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





For
the quarterly period ended September 30, 2009





OR





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





Commission
File Number: 001-32634





SMART
ONLINE, INC.


(Exact
name of registrant as specified in its charter)





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





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





(919)
765-5000


(Registrant’s
telephone number, including area code)










x o





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


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





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


As of
November 11, 2009, there were 18,332,542 shares of the registrant’s common
stock, par value $0.001 per share, outstanding.







EXPLANATORY
NOTE




Smart
Online, Inc. (the "Company") is filing this Amendment No. 1 to the
Quarterly Report on Form 10-Q/A (the "Form 10-Q/A") to amend its
Quarterly Report on Form 10-Q for the quarter ended September 30, 2009,
which was filed with the Securities and Exchange Commission ("SEC") on November
16, 2009 (the "Original Filing" and together with the Form 10-Q/A, the
"Form 10-Q") to include restated unaudited consolidated financial
statements as described in Note 1 to the unaudited consolidated financial
statements.




The
Company has previously included the restated information in footnote 13 to the
Annual Report on Form 10-K for the year ended December 31, 2009, which
was filed with the Securities and Exchange Commission ("SEC") on April 15,
2010.




The
Company has restated its previously issued consolidated financial statements as
of and for the year ended December 31, 2008 and unaudited consolidated
financial statements as of and for the quarter ended September 30, 2009 to
include net subscription revenue as compared to gross subscription revenue as
presented in the original filings.  We typically have a revenue-share
arrangement with our marketing partners in order to encourage them to market our
products and services to their customers.  Subscriptions are generally
payable on a monthly basis and are typically paid via credit card of the
individual end user.  We accrue any payments received in advance of the
subscription period as deferred revenue and amortize them over the subscription
period.  In the past, we recognized all subscription revenue on a gross
basis and in accordance with our policy to periodically review our accounting
policies we identified the fact that certain contracts required the reporting of
subscription revenue on a gross basis and others on a net basis according to US
GAAP.  On that basis, we continue to report subscription revenue from
certain contracts on a gross basis and others on a net basis.  The net
effect of this reclassification of expenses only impacts gross revenue and
certain gross expenses; it does not change our net income.




In addition to the restatement of
subscription revenue, we restated the value of the iMart trade name as of
December 31, 2008 because of a recalculation of the net royalty method of
valuation.  The restatement caused an increase in the amount of loss on
impairment of intangible assets for the year ended December 31, 2008 in the
amount of $230,000.  The restated total loss on impairment of intangible
assets is $3,702,141 as compared to the original loss of $3,472,141.  The
restated loss for the year ended December 31, 2008 decreased the total assets by
$230,000 to $2,992,717 and increased the accumulated deficit to $72,908,076 as
reflected in the restated Balance Sheet as of December 31, 2008.




This
Form 10-Q/A amends Part I of the Company's Original Filing to reflect
the restatement of revenue previously reported on a gross basis to a net revenue
presentation.   For the convenience of the reader, this Quarterly
Report on Form 10-Q/A sets forth the Original Filing in its entirety. Other
than, as described above and as indicated in Note 7, “Subsequent Events”, none
of the other disclosures in the Original Filing have been amended or updated.
Among other things, forward-looking statements made in the Original Filing have
not been revised to reflect events that occurred or facts that became known to
the Company after the filing of the Original Filing, and such forward-looking
statements should be read in their historical context. Accordingly, this
Quarterly Report on Form 10-Q/A should be read in conjunction with the
Company's filings with the Securities and Exchange Commission subsequent to the
Original Filing.


Page
1 of 39


SMART
ONLINE, INC.





FORM
10-Q/A


For the
Quarterly Period Ended September 30, 2009





TABLE
OF CONTENTS





Page No.PART
      I  – FINANCIAL INFORMATIONItem
      1.
                    
                    Financial
      StatementsConsolidated
      Balance Sheets as of September 30, 2009 (unaudited) and December 31,
      2008
                    
                    3Consolidated
      Statements of Operations (unaudited) for the three and nine months ended
      September 30, 2009 and 2008
                    
                    4Consolidated
      Statements of Cash Flows (unaudited) for the nine months ended September
      30, 2009 and 2008
                    
                    5Notes
      to Consolidated Financial Statements (unaudited)
                    
                    6Item
      2.
                    
                    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                    
                    20Item
      3.
                    
                    Quantitative
      and Qualitative Disclosures About Market Risk
                    
                    31Item
      4.
                    
                    Controls
      and Procedures
                    
                    31Item
      4T.
                    
                    Controls
      and Procedures
                    
                    31PART
      II  – OTHER INFORMATIONItem
      1.
                    
                    Legal
      Proceedings
                    
                    32Item
      1A.
                    
                    Risk
      Factors
                    
                    33Item
      2.
                    
                    Unregistered
      Sales of Equity Securities and Use of Proceeds
                    
                    38Item
      6.
                    
                    Exhibits
                    
                    38Signatures
                    
                    39


Page
2 of 39


PART
I – FINANCIAL INFORMATION


Item 1.     Financial Statements


SMART
ONLINE, INC.


CONSOLIDATED
BALANCE SHEETS




September 30,
                            
                            
                            December 31,2009
                            
                            
                            2008(unaudited)
                            
                            
                            (Restated)ASSETSCurrent
      Assets:Cash
      and Cash Equivalents
                            
                            $
                            18,749
                            
                            
                            $
                            18,602Accounts
      Receivable, Net
                            
                            
                            10,510
                            
                            
                            
                            184,930Note
      Receivable
                            
                            
                            -
                            
                            
                            
                            60,000Prepaid
      Expenses
                            
                            
                            274,069
                            
                            
                            
                            289,372Total
      current assets
                            
                            
                            303,328
                            
                            
                            
                            552,904Property
      and equipment, net
                            
                            
                            267,716
                            
                            
                            
                            365,993Capitalized
      software, net
                            
                            
                            468,056
                            
                            
                            
                            261,221Note
      Receivable, non-current
                            
                            
                            -
                            
                            
                            
                            372,317Prepaid
      expenses, non-current
                            
                            
                            147,600
                            
                            
                            
                            258,301Intangible
      assets, net
                            
                            
                            599,309
                            
                            
                            
                            1,180,245Other
      assets
                            
                            
                            2,087
                            
                            
                            
                            1,736TOTAL
      ASSETS
                            
                            $
                            1,788,096
                            
                            
                            $
                            2,992,717LIABILITIES
      AND STOCKHOLDERS' EQUITY (DEFICIT)Current
      liabilitiesAccounts
      payable
                            
                            $
                            752,337
                            
                            
                            $
                            398,237Notes
      payable (See Note 3)
                            
                            
                            2,504,850
                            
                            
                            
                            2,341,177Deferred
      revenue (See Note 2)
                            
                            
                            166,142
                            
                            
                            
                            323,976Accrued
      liabilities (See Note 2)
                            
                            
                            2,107,751
                            
                            
                            
                            478,917Total
      current liabilities
                            
                            
                            5,531,080
                            
                            
                            
                            3,542,307Long-term
      liabilities:Long-term
      portion of notes payable (See Note 3)
                            
                            
                            8,042,838
                            
                            
                            
                            5,327,211Deferred
      revenue (See Note 2)
                            
                            
                            37,018
                            
                            
                            
                            67,353Total
      long-term liabilities
                            
                            
                            8,079,856
                            
                            
                            
                            5,394,564Total
      liabilities
                            
                            
                            13,610,936
                            
                            
                            
                            8,936,871Commitments
      and contingencies (See Note 4)Stockholders'
      equity (deficit):Preferred
      stock, 0.001 par value, 5,000,000 shares authorized, no
    sharesissued
      and outstanding at September 30, 2009 and December 31,
2008Common
      Stock, $.001 par value, 45,000,000 shares authorized,18,332,542
      and 18,333,601 shares Issued and Outstanding atSeptember
      30, 2009 and December 31, 2008 respectively.
                            
                            
                            18,333
                            
                            
                            
                            18,334Additional
      paid-in capital
                            
                            
                            67,032,729
                            
                            
                            
                            66,945,588Accumulated
      deficit
                            
                            
                            (78,873,902
                            )
                            
                            
                            (72,908,076
                            )Total
      Stockholders’ Deficit
                            
                            
                            (11,822,840
                            )
                            
                            
                            (5,944,154
                            )TOTAL
      LIABILITIES AND STOCKHOLDERS’ DEFICIT
                            
                            $
                            1,788,096
                            
                            
                            $
                            2,992,717





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


Page
3 of 39


SMART
ONLINE, INC.


CONSOLIDATED
STATEMENTS OF OPERATIONS


(Unaudited)


Three Months Ended
                  
                  
                  Nine Months EndedSeptember30,
                    2009
                  
                  
                  September30,
                    2008
                  
                  
                  September30,
                    2009
                  
                  
                  September30,
                    2008(Restated)
                  
                  
                  (Restated)
                  
                  
                  (Restated)
                  
                  
                  (Restated)REVENUES:Subscription
      fees
                  
                  $
                  159,149
                  
                  
                  $
                  364,136
                  
                  
                  $
                  610,751
                  
                  
                  $
                  1,307,934Professional
      service fees
                  
                  
                  63,200
                  
                  
                  
                  574,970
                  
                  
                  
                  261,699
                  
                  
                  
                  2,011,497License
      fees
                  
                  
                  11,250
                  
                  
                  
                  291,250
                  
                  
                  
                  33,750
                  
                  
                  
                  395,000Hosting
      fees
                  
                  
                  33,751
                  
                  
                  
                  70,856
                  
                  
                  
                  139,007
                  
                  
                  
                  166,534Other
      revenue
                  
                  
                  26,300
                  
                  
                  
                  31,501
                  
                  
                  
                  100,777
                  
                  
                  
                  108,432Total
      revenues
                  
                  
                  293,650
                  
                  
                  
                  1,332,713
                  
                  
                  
                  1,145,984
                  
                  
                  
                  3,989,397COST
      OF REVENUES
                  
                  
                  430,967
                  
                  
                  
                  409,414
                  
                  
                  
                  1,125,901
                  
                  
                  
                  1,768,609GROSS
      PROFIT
                  
                  
                  (137,317
                  )
                  
                  
                  923,299
                  
                  
                  
                  20,083
                  
                  
                  
                  2,220,788OPERATING
      EXPENSES:General
      and administrative
                  
                  
                  2,355,353
                  
                  
                  
                  1,115,398
                  
                  
                  
                  4,112,993
                  
                  
                  
                  3,456,054Sales
      and marketing
                  
                  
                  180,759
                  
                  
                  
                  454,625
                  
                  
                  
                  707,289
                  
                  
                  
                  1,280,700Research
      and development
                  
                  
                  36,406
                  
                  
                  
                  887,657
                  
                  
                  
                  540,232
                  
                  
                  
                  1,798,190Loss
      on Impairment
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  438,286
                  
                  
                  
                  -(Gain)
      loss on disposal of assets, net
                  
                  
                  (12,307
                  )
                  
                  
                  -
                  
                  
                  
                  (22,574
                  )
                  
                  
                  -Total
      operating expenses
                  
                  
                  2,560,211
                  
                  
                  
                  2,457,680
                  
                  
                  
                  5,776,226
                  
                  
                  
                  6,534,944LOSS
      FROM OPERATIONS
                  
                  
                  (2,697,528
                  )
                  
                  
                  (1,534,381
                  )
                  
                  
                  (5,756,143
                  )
                  
                  
                  (4,314,156
                  )OTHER
      INCOME (EXPENSE):Interest
      expense, net
                  
                  
                  (169,609
                  )
                  
                  
                  (150,510
                  )
                  
                  
                  (455,951
                  )
                  
                  
                  (519,746
                  )Gain
      on legal settlements, net
                  
                  
                  -
                  
                  
                  
                  291,407
                  
                  
                  
                  6,000
                  
                  
                  
                  291,408Other
      Income
                  
                  
                  -
                  
                  
                  
                  1,065
                  
                  
                  
                  10,267
                  
                  
                  
                  17,133Total
      other expense
                  
                  
                  (169,609
                  )
                  
                  
                  141,962
                  
                  
                  
                  (439,684
                  )
                  
                  
                  (211,205
                  )NET
      LOSS
                  
                  $
                  (2,867,137
                  )
                  
                  $
                  (1,392,419
                  )
                  
                  $
                  (6,195,827
                  )
                  
                  $
                  (4,525,361
                  )NET
      LOSS PER COMMON SHARE:Basic
      and fully diluted
                  
                  $
                  (0.16
                  )
                  
                  $
                  (0.08
                  )
                  
                  $
                  (0.34
                  )
                  
                  $
                  (0.25
                  )WEIGHTED-AVERAGE
      NUMBER OF SHARES USED IN COMPUTING NET LOSS PER COMMON
    SHAREBasic
      and fully diluted
                  
                  
                  18,332,542
                  
                  
                  
                  18,378,940
                  
                  
                  
                  18,332,653
                  
                  
                  
                  18,282,180





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


Page
4 of 39


SMART
ONLINE, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)




Nine Months
                  
                  
                  Nine MonthsEnded
                  
                  
                  EndedSeptember 30,
                    2009
                  
                  
                  September 30,
                    2008CASH FLOWS FROM OPERATING ACTIVITIES:Net
      Loss
                  
                  $
                  (6,195,827
                  )
                  
                  $
                  (4,525,361
                  )Adjustments
      to reconcile let loss to net cash used in operating
      activities:Depreciation
      and amortization
                  
                  
                  462,761
                  
                  
                  
                  638,930Amortization
      of deferred financing costs
                  
                  
                  -
                  
                  
                  
                  301,249Bad
      debt expense
                  
                  
                  2,207,685
                  
                  
                  
                  266,875Stock-based
      compensation expense
                  
                  
                  88,235
                  
                  
                  
                  341,722Loss
      on impairment of intangible assets
                  
                  
                  438,228
                  
                  
                  
                  -Gain
      on disposal of assets
                  
                  
                  (22,574
                  )
                  
                  
                  (3,729
                  )Changes
      in assets and liabilities:Accounts
      receivable
                  
                  
                  213,010
                  
                  
                  
                  (120,108
                  )Notes
      receivable
                  
                  
                  (3,228,038
                  )
                  
                  
                  (148,236
                  )Costs
      in excess of billings
                  
                  
                  -
                  
                  
                  
                  -Prepaid
      expenses
                  
                  
                  126,005
                  
                  
                  
                  (544,297
                  )Other
      assets
                  
                  
                  (352
                  )
                  
                  
                  36,660Deferred
      revenue
                  
                  
                  (188,170
                  )
                  
                  
                  (330,686
                  )Accounts
      payable
                  
                  
                  1,768,181
                  
                  
                  
                  10,836Accrued
      and other expenses
                  
                  
                  1,627,739
                  
                  
                  
                  96,189Net
      cash used in operating activities
                  
                  
                  (2,703,117
                  )
                  
                  
                  (3,979,956
                  )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchases
      of furniture and equipment
                  
                  
                  (14,565
                  )
                  
                  
                  (293,656
                  )Capitalized
      software
                  
                  
                  (206,835
                  )
                  
                  
                  (120,191
                  )Proceeds
      from sale of furniture and equipment
                  
                  
                  45,362
                  
                  
                  
                  13,564Net
      Cash used in Investing Activities
                  
                  
                  (176,038
                  )
                  
                  
                  (400,283
                  )CASH
      FLOWS FROM FINANCING ACTIVITIES:Repayments
      on notes payable
                  
                  
                  (5,068,063
                  )
                  
                  
                  (5,022,392
                  )Debt
      borrowings
                  
                  
                  7,947,365
                  
                  
                  
                  5,861,924Issuance
      of common Stock
                  
                  
                  -
                  
                  
                  
                  97,500Net
      cash provided by financing activities
                  
                  
                  2,879,302
                  
                  
                  
                  937,032NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
                  
                  
                  147
                  
                  
                  
                  (3,443,209
                  )CASH
      AND CASH EQUIVALENTS,BEGINNING
      OF PERIOD
                  
                  
                  18,602
                  
                  
                  
                  3,473,959CASH
      AND CASH EQUIVALENTS, END OF PERIOD
                  
                  $
                  18,749
                  
                  
                  $
                  30,750Supplemental
      disclosures of cash flow information:Cash
      paid during the period for:Interest
                  
                  $
                  461,360
                  
                  
                  $
                  243,168Taxes
                  
                  $
                  10
                  
                  
                  $
                  38,905Supplemental
      schedule of non-cash financing activities:Conversion
      of debt to equity
                  
                  $
                  -
                  
                  
                  $
                  228,546





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


Page
5 of 39


SMART
ONLINE, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(Unaudited)





1.   SUMMARY OF BUSINESS AND SIGNIFICANT
ACCOUNTING POLICIES


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





Basis of
Presentation - The financial statements as of and for the three and nine
months ended September 30, 2009 and 2008 included in this Quarterly Report
on Form 10-Q/A are unaudited. The balance sheet as of December 31, 2008 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, 2008 filed with the
Securities and Exchange Commission (the “SEC”) on March 30, 2009 (the “2008
Annual Report”).





The
financial statements have been prepared in accordance with United State
Generally Accepted Accounting Principles (“US GAAP”). In the opinion of the
Company’s management, the unaudited statements in this Quarterly Report on Form
10-Q/A include all normal and recurring adjustments necessary for the fair
presentation of the Company’s statement of financial position as of September
30, 2009, and its results of operations and cash flows for the three and nine
months ended September 30, 2009 and 2008. The results for the three and nine
months ended September 30, 2009 are not necessarily indicative of the results to
be expected for the fiscal year ending December 31, 2009.





The
accompanying financial statements have been prepared on a going concern basis,
which contemplates the realization of assets and the satisfaction of liabilities
in the normal course of business. During the three and nine months ended
September 30, 2009 and 2008, the Company incurred net losses as well as negative
cash flows, is involved in a class action lawsuit (See Note 4, “Commitments and
Contingencies,” in the 2008 Annual Report), and the repayment of the legal
fees advanced on behalf of former officers and employees who were convicted in
Federal Court and had deficiencies in working capital. These factors indicate
that the Company may be unable to continue as a going concern.





The
financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or the amounts or
classification of liabilities that might be necessary should the Company be
unable to continue as a going concern. At November 6, 2009, the Company does
have a commitment from its convertible secured subordinated noteholders to
purchase up to an additional $6.25 million in convertible notes upon approval
and call by the Company’s Board of Directors. There can be no assurance that, if
the noteholders do not purchase the $6.25 million in convertible notes, the
Company will be able to obtain alternative funding. There can be no assurance
that the Company’s efforts to raise capital or increase revenue will be
successful. If these efforts are unsuccessful, the Company may have to cease
operations and liquidate the business. The Company’s future plans include the
introduction of its new One BizTM platform, the development of additional new
products and applications, and further enhancement of its existing
small-business applications and tools. The Company’s continuation as a
going concern depends upon its capability to generate sufficient cash flows to
meet its obligations on a timely basis, to obtain additional financing as may be
required, and ultimately to attain profitable operations and positive cash
flows.





Significant
Accounting Policies - In the opinion of the Company’s management, the
significant accounting policies used for the three and nine months ended
September 30, 2009 are consistent with those used for the years ended December
31, 2008 and 2007. Accordingly, please refer to the 2008 Annual Report for the
Company’s significant accounting policies.





Use of Estimates
- The preparation of financial statements in conformity with US 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.


Page
6 of 39


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





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





Principles of
Consolidation - The accompanying financial statements for the three and
nine months ended September 30, 2008 include the accounts of the Company and its
former 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. On December 31, 2008, each of Smart CRM and
Smart Commerce were merged into the Company.





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





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





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





Additionally,
from time to time the Company, as part of its negotiated contracts, has granted
extended payment terms to its strategic partners. As payments become due under
the terms of the contract, they are invoiced and reclassified as accounts
receivable. During the second quarter of 2008, the Company entered into a web
services agreement with a direct-selling organization customer that provided for
extended payment terms related to both professional services and the grant of a
software license. During the third quarter of 2008, this customer began
experiencing cash flow difficulties and has since significantly slowed its
payments to the Company. In addition, the Company entered into a web services
agreement with a real estate services customer in the third quarter of 2007 that
called for contractual payments against a note receivable upon delivery and
acceptance of a custom application. The Company and the customer are currently
in discussions with respect to whether the application was delivered as per the
specifications, and the customer has not commenced payment subject to the
outcome of these discussions.





Based on
these criteria, management determined that at September 30, 2009, an allowance
for doubtful accounts of $2,193,776 was required, comprising the full
outstanding balance of the direct-selling organization customer’s account and
contract receivable and the entire amount of the real estate services customer’s
note receivable.  The total allowance for doubtful accounts includes the
additional reserve for bad debt of $1,804,207 for the possibility that it will
not be able to collect the amount of these legal expenses that the Company will
be required to advance on behalf of Michael Nouri and Eric Reza Nouri, both of
whom were convicted on criminal charges brought by the US Department of
Justice.  The total identified to date equals $1,804,207.  The amount
could exceed $2,400,000.





Intangible
Assets - Intangible assets consist primarily of assets obtained
through the acquisitions of iMart Incorporated (“iMart”) in 2005 and include
customer bases, acquired technology non-compete agreements, trademarks, and
trade names. The Company also owns several copyrights and trademarks related to
products, names, and logos used throughout its non-acquired product
lines. All assets are amortized on a straight-line basis over their
estimated useful lives with the exception of the iMart trade name, which is
deemed by management to have an indefinite life and is not amortized. During the
nine month period ending September 30, 2009, we impaired the value of a portion
of the customer base intangible asset due to the fact that the Company is no
longer doing business with the customer.





Revenue
Recognition - The Company derives revenue primarily from subscription
fees charged to customers accessing its SaaS applications; the perpetual or term
licensing of software platforms or applications; and professional services,
consisting of consulting, development, hosting, and maintenance services. These
arrangements may include delivery in multiple-element arrangements if the
customer purchases a combination of products and/or services. Because the
Company licenses, sells, leases, or otherwise markets computer software, it uses
the residual method pursuant to the US GAAP, 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.


Page
7 of 39


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





1.  
persuasive evidence of an arrangement exists





2.  
delivery has occurred





3.  
the fee is fixed or determinable





4.  
collectability 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 collectability is
deemed not probable, revenue is deferred until payment is received or collection
becomes probable, whichever is earlier. The determination of whether fees are
collectible requires judgment of management, and the amount and timing of
revenue recognition may change if different assessments are made.





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





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





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


Because
our customers generally do not have the contractual right to take possession of
the software we license or market at any time, we recognize revenue on hosting
and maintenance fees as the services are provided in accordance with US GAAP
 provisions
relating to the right to use software stored on another entity’s
hardware.





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





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


Page
8 of 39


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





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





Beginning
in May 2008, the Company determined that it was strategically desirable to
develop an industry standard platform and enhance the current SaaS applications.
A detailed design plan indicated that the product was technologically feasible,
and in July 2008, development commenced. All related costs from that point in
time are being capitalized in accordance with current US GAAP.  The first
release of the revised product took place in July 2009.   At that
time, additional development costs were no longer capitalized and the costs
capitalized to that point are now being amortized.





Advertising
Costs - The Company expenses all advertising costs as they are incurred.
The amounts charged to sales and marketing expense during the third quarter of
2009 and 2008 were $3,000 and $7,795, respectively. During the first nine months
of 2009 and 2008, these amounts were $4,032 and $20,205,
respectively.





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





Stock-Based
Compensation  -  The Company adopted US
GAAP provisions related to share-based payments which require companies to
expense the value of employee stock options, restricted stock, and similar
awards and apply to all such securities outstanding and vested.





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





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





Three Months Ended
                  
                  
                  Nine Months EndedSeptember 30,
                    2009
                  
                  
                  September 30,
                    2008
                  
                  
                  September 30,
                    2009
                  
                  
                  September 30,
                    2008Compensation
      expense included in G&A expense related to stock
    options
                  
                  $
                  5,191
                  
                  
                  $
                  30,995
                  
                  
                  $
                  40,155
                  
                  
                  $
                  106,199Compensation
      expense included in G&A expense related to restricted stock
      awards
                  
                  
                  560
                  
                  
                  
                  50,583
                  
                  
                  
                  48,080
                  
                  
                  
                  235,523Total
      expense
                  
                  $
                  5,751
                  
                  
                  $
                  81,578
                  
                  
                  $
                  88,235
                  
                  
                  $
                  341,722


Page
9 of 39


The fair
value of option grants under the Company’s equity compensation plan and other
stock option issuances during the three months and nine months ended September
30, 2009 and 2008 were estimated using the Black-Scholes option-pricing model
with the following weighted-average assumptions:





Three Months Ended
                            
                            
                            Nine Months EndedSeptember 30,
                              2009
                            
                            
                            September 30,
                              2008
                            
                            
                            September 30,
                              2009
                            
                            
                            September 30,
                              2008Dividend
      yield
                            
                            
                            0.0
                            %
                            
                            
                            0.0
                            %
                            
                            
                            0.0
                            %
                            
                            
                            0.0
                            %Expected
      volatility
                            
                            
                            70
                            %
                            
                            
                            40
                            %
                            
                            
                            69
                            %
                            
                            
                            46
                            %Risk-free
      interest rate
                            
                            
                            2.37
                            %
                            
                            
                            4.39
                            %
                            
                            
                            2.30
                            %
                            
                            
                            4.43
                            %Expected
      lives (years)
                            
                            
                            4.0
                            
                            
                            
                            4.3
                            
                            
                            
                            4.0
                            
                            
                            
                            4.4





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





The
following is a summary of the stock option activity for the nine months ended
September 30, 2009:





Shares
                  
                  
                  Weighted
                    Average
                    Exercise
                    PriceBALANCE,
      December 31, 2008
                  
                  
                  271,250
                  
                  
                  $
                  5.89Granted
                  
                  
                  40,000
                  
                  
                  
                  1.10Forfeited
                  
                  
                  (173,750
                  )
                  
                  
                  5.81Exercised
                  
                  
                  0
                  
                  
                  
                  -BALANCE,
      September 30, 2009
                  
                  
                  137,500
                  
                  
                  $
                  4.32





Recently Issued
Accounting Pronouncements -. The current US GAAP pronouncements
concerning the life of intangible assets requires entities to consider their own
historical experience in renewing or extending similar arrangements when
developing assumptions regarding the useful lives of intangible assets and also
mandates certain related disclosures.





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





2.   ASSETS &
LIABILITIES





Prepaid
Expenses


In July
2008, the Company entered into a 36-month sublease agreement with Advantis Real
Estate Services Company for approximately 9,837 square feet of office space in
Durham, North Carolina, into which the Company relocated its headquarters in
September 2008. The agreement included the conveyance of certain furniture to
the Company without a stated value and required a lump-sum, upfront payment of
$500,000 that was made in September 2008. Management has assessed the fair
market value of the furniture to be approximately $50,000, and this amount was
capitalized and is subject to depreciation in accordance with the Company’s
fixed asset policies. The remainder of the payment was recorded as prepaid
expense; with the portion, relating to rent for periods beyond the next twelve
months classified as non-current, and is being amortized to rent expense over
the term of the lease.  The Company’s prepaid sublease with Advantis Real
Estate Services Company includes an expiration date of September 2011. On
November 3, 2009, the Company received notice from the prime landlord of the
office space that the Company’s sub-landlord, Advantis Real Estate Services
Company, had defaulted on the prime lease, thereby giving the prime landlord the
right to terminate the Company’s sublease, and that the prime landlord was
seeking to renegotiate the occupancy terms for the Company’s office space. The
Company is currently engaged in discussions with the prime landlord to lease the
office space from the prime landlord on a prime lease basis.


Page
10 of 39


Intangible
Assets


The
following table summarizes information about intangible assets at September 30,
2009:


Asset Category
                          
                          Value
                            Assigned
                          
                          
                          Residual
                            Value
                          
                          
                          Weighted
                            Average
                            Amortization
                            Period
                            (in Years)
                          
                          
                          Accumulated
                            Amortization
                          
                          
                          Carrying
                            Value(
      Restated)
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (
      Restated)Customer base
                          
                          $
                          1,012,421
                          
                          
                          $
                          -
                          
                          
                          
                          6.2
                          
                          
                          $
                          801,464
                          
                          
                          $
                          210,957Acquired
      technology
                          
                          
                          501,264
                          
                          
                          
                          -
                          
                          
                          
                          3.0
                          
                          
                          
                          501,264
                          
                          
                          
                          -Non-compete
      agreements
                          
                          
                          801,785
                          
                          
                          
                          -
                          
                          
                          
                          4.0
                          
                          
                          
                          793,433
                          
                          
                          
                          8,352Trademarks
      and copyrights
                          
                          
                          52,372
                          
                          
                          
                          -
                          
                          
                          
                          9.7
                          
                          
                          
                          52,372
                          
                          
                          
                          -Trade
      name
                          
                          
                          150,000
                          
                          
                          
                          N/A
                          
                          
                          
                          N/A
                          
                          
                          
                          N/A
                          
                          
                          
                          150,000Totals
                          
                          $
                          2,517,842
                          
                          
                          $
                          -
                          
                          
                          
                          
                          
                          
                          $
                          2,148,533
                          
                          
                          $
                          369,309





Intangible
assets acquired were valued using the standard of “fair value” defined in US
GAAP related to business combinations , as “the amount at which an asset (or
liability) could be bought (or incurred) or sold (or settled) in a current
transaction between willing parties, that is, other than in a forced or
liquidation sale.” Copyrights and trademarks were capitalized using the costs of
all legal and application fees incurred.





We
restated the value of the iMart trade name as of December 31, 2008, as presented
in the Form 10-K filed for the year ended December 31, 2009, because of a
recalculation of the net royalty method of valuation.  The restatement
caused an increase in the amount of loss on impairment of intangible assets for
the year ended December 31, 2008 in the amount of $230,000 and resulted in a
like reduction of the value of the trade name intangible asset.





Accrued
Liabilities





At
September 30, 2009, the Company had accrued liabilities totaling $2,107,751.
This amount consisted primarily of $117,102 of liability accrued related to the
development of the Company’s custom accounting application; $1,804,207 related
to legal expenses associated with the Company’s former officers and
employees  (see Note 4, “Commitments and Contingencies”); $24,518 for
tax-related liabilities associated with the vesting of restricted stock; $10,043
of loss estimated on a long-term customer contract; $25,685 of accrued payroll;
$87,688 of convertible note interest payable and other liabilities of
$36,617.





At
December 31, 2008, accrued liabilities totaled $478,917. This amount consisted
primarily of $117,102 of liability related to the above-noted development of the
Company’s custom accounting application; $137,500 related to legal reserves (see
Note 4, “Commitments and Contingencies”); $30,198 for tax-related liabilities
associated with the vesting of restricted stock; $30,903 of loss estimated on a
long-term customer contract; $79,300 of cash collected through the Company’s
merchant account on behalf of a customer; $54,467 of convertible note interest
payable and other liabilities of $29,447.





Deferred
Revenue





Deferred
revenue comprises the following items:





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





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





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





September 30,
                    2009
                  
                  
                  December 31,
                    2008Subscription
      fees
                  
                  $
                  56,010
                  
                  
                  $
                  89,852License
      fees
                  
                  
                  75,000
                  
                  
                  
                  108,750Professional
      service fees
                  
                  
                  72,150
                  
                  
                  
                  192,727Totals
                  
                  $
                  203,160
                  
                  
                  $
                  391,329Current
      portion
                  
                  $
                  166,142
                  
                  
                  $
                  323,976Non-current
      portion
                  
                  
                  37,018
                  
                  
                  
                  67,353Totals
                  
                  $
                  203,160
                  
                  
                  $
                  391,329


Page
11 of 39


3.   NOTES PAYABLE





Convertible
Notes





As of
September 30, 2009, the Company had $7.85 million aggregate principal amount of
convertible secured subordinated notes due November 14, 2010 (the “notes”)
outstanding, after the $200,000 reduction of such current outstanding debt on
account of the sale-leaseback described in item 4, Commitments and
Contingencies, below. On November 14, 2007, in an initial closing, the
Company sold $3.3 million aggregate principal amount of notes (the “Initial
Notes”). In addition, the noteholders committed to purchase on a pro rata basis
up to $5.2 million aggregate principal amount of notes in future closings upon
approval and call by the Company’s Board of Directors. On August 12, 2008, the
Company exercised its option to sell $1.5 million aggregate principal amount of
notes with substantially the same terms and conditions as the Initial Notes (the
“Additional Notes”). In connection with the sale of the Additional Notes, the
noteholders holding a majority of the aggregate principal amount of the notes
then outstanding agreed to increase the aggregate principal amount of notes that
they are committed to purchase from $8.5 million to $15.3 million.





On
November 21, 2008, the Company sold $500,000 aggregate principal amount of notes
(the “New Notes”) to two new investors with substantially the same terms and
conditions as the previously outstanding notes.





On each
of January 6, 2009, February 24, 2009, April 3, 2009, and June 2, 2009 the
Company sold a note in the principal amount of $500,000 (total $2,000,000)
to a current noteholder with substantially the same terms and conditions as the
previously outstanding notes.





On each
of July 16, 2009, August 26, 2009, September 8, 2009, October 5, 2009 and
October 9, 2009 the Company sold a note in the principal amount of $250,000
(total $1,250,000) to a current noteholder with substantially the same terms and
conditions as the previously outstanding notes.  On November 6, 2009, the
Company sold a note in the principal amount of $500,000 to a current noteholder
with substantially the same terms and conditions.





Also on
February 24, 2009, the noteholders holding a majority of the aggregate principal
amount of the notes outstanding agreed that the Company may sell up to $6
million aggregate principal amount of notes to new investors or existing
noteholders at any time on or before December 31, 2009 with a maturity date of
November 14, 2010 or later. In addition, the maturity date definition for each
of the notes was changed from November 14, 2010 to the date upon which the note
is due and payable, which is the earlier of (1) November 14, 2010, (2) a change
of control, or (3) if an event of default occurs, the date upon which
noteholders accelerate the indebtedness evidenced by the notes.





The
formula for calculating the conversion price of the notes was also amended such
that the conversion price of each outstanding note and any additional note sold
in the future would be the same and set at the lowest “applicable conversion
price,” as described below.





The
Company is obligated to pay interest on the notes at an annualized rate of 8%
payable in quarterly installments commencing three months after the purchase
date of the notes. 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 November 14, 2010 or a merger or acquisition or other transaction
pursuant to which existing stockholders of the Company hold less than 50% of the
surviving entity, or the sale of all or substantially all of the Company’s
assets, or similar transaction, or event of default, each noteholder in its sole
discretion shall have the option to:





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





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





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





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





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


Page
12 of 39





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





in each
case as adjusted for stock splits, dividends or combinations, recapitalizations
or similar events.





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





The notes
and the common stock into which they may be converted have not been registered
under the Securities Act of 1933, as amended (the “Securities Act”), or the
securities laws of any other jurisdiction. As a result, offers and sales of the
notes were made pursuant to Regulation D of the Securities Act and only made to
accredited investors. The investors in the Initial Notes include (i) The
Blueline Fund, which originally recommended Philippe Pouponnot, a former
director of the Company, for appointment to the Company’s Board of Directors;
(ii) Atlas Capital SA (“Atlas”), an affiliate of the Company that originally
recommended Shlomo Elia, one of the Company’s current directors, for appointment
to the Board of Directors; (iii) Crystal Management Ltd. (“Crystal”), which is
owned by Doron Roethler, who subsequently served as Chairman of the Company’s
Board of Directors from December 2007 until December 9, 2008 and Chairman and
Interim President and Chief Executive Officer from December 9, 2008
until  May 19, 2009,  and serves as the noteholders’ bond
representative; and (iv) William Furr, who is the father of Thomas Furr, who, at
the time, was one of the Company’s directors and executive officers. The
investors in the Additional Notes are Atlas and Crystal. The investors in the
New Notes are not affiliated with the Company.  Atlas purchased $6,800,000
and Union Bancaire Privee purchased $500,000 of the $9,050,000 aggregate
principal amount of notes issued through November 11, 2009.





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.





Line
of Credit





On
November 14, 2006, the Company entered into a revolving credit arrangement with
Wachovia Bank, NA (“Wachovia”) for $1.3 million to be used for general working
capital. Any advances made on the line of credit were to be paid off no later
than August 1, 2007, with monthly payments of accrued interest on any
outstanding balance commencing on December 1, 2006. The interest accrued on the
unpaid principal balance at the LIBOR Market Index Rate plus 0.9%. The line of
credit was secured by the Company’s deposit account at Wachovia and an
irrevocable standby letter of credit in the amount of $1.3 million issued by
HSBC Private Bank (Suisse) SA (“HSBC”) with Atlas, a current stockholder, as
account party.





On
January 24, 2007, the Company entered into an amendment to its line of credit
with Wachovia to increase the available principal from $1.3 million to $2.5
million and to extend the maturity date from August 1, 2007 to August 1, 2008.
The amended line of credit was secured by the Company’s deposit account at
Wachovia and a modified irrevocable standby letter of credit in the amount of
$2.5 million issued by HSBC with Atlas as account party. 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 Commercial Bank (“Paragon”) that is renewable on an annual basis 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
were to be paid off no later than February 19, 2009, subject to extension due to
renewal, with monthly payments being applied first to accrued interest and then
to principal. The interest accrued 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 with Atlas as account party that expires on February
18, 2010. The Company also has agreed with Atlas that in the event of a default
by the Company in the repayment of the line of credit that results in the letter
of credit being drawn, the Company shall reimburse Atlas any sums that Atlas is
required to pay under such letter of credit.  At the sole discretion of 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.





On
February 19, 2009, the Company renewed its revolving credit arrangement with
Paragon. Any advances made on the line of credit must be paid off no later than
February 19, 2010. Interest shall accrue on the unpaid principal balance at the
Wall Street Journal's published Prime Rate, but at no time shall the interest
rate be less than 5.5%. As of November 10, 2009, the Company had an outstanding
balance of $2.05 million under the line of credit.  As of September 30,
2009, the Company had notes payable totaling $10,547,688. The detail of these
notes is as follows:


Page
13 of 39




Note Description
                      
                      Short-Term
                        Portion
                      
                      
                      Long-Term
                        Portion
                      
                      
                      TOTAL
                      
                      
                      Maturity
                      
                      
                      RateParagon
      Commercial Bank credit line
                      
                      $
                      2,401,124
                      
                      
                      $
                      -
                      
                      
                      $
                      2,401,124
                      
                      
                      Feb
      ‘10
                      
                      
                      
                      5.5
                      %Various
      capital leases
                      
                      
                      40,205
                      
                      
                      
                      192,838
                      
                      
                      
                      233,043
                      
                      
                      Various
                      
                      
                      
                      8-19
                      %Insurance
      premium note
                      
                      
                      63,521
                      
                      
                      
                      -
                      
                      
                      
                      63,521
                      
                      
                      Jul
      ‘10
                      
                      
                      
                      5.4
                      %Convertible
      notes
                      
                      
                      -
                      
                      
                      
                      7,850,000
                      
                      
                      
                      7,850,000
                      
                      
                      Nov
      ‘10
                      
                      
                      
                      8.0
                      %TOTAL
                      
                      $
                      2,504,850
                      
                      
                      $
                      8,042,838
                      
                      
                      $
                      10,547,688





4. 
         COMMITMENTS AND
CONTINGENCIES





Lease
Commitments





The
Company leases computer and office equipment under capital lease agreements that
expire through August 2019. Total amounts financed under these capital leases
were $233,043and $53,517 at September 30, 2009 and December 31, 2008,
respectively, net of accumulated amortization of $39,121 and $18,647,
respectively. The current and non-current portions of the capital leases have
been recorded in current and long-term portions of notes payable on the balance
sheets as of September 30, 2009 and December 31, 2008. See also Note 3, “Notes
Payable.”





In 2008,
the Company entered into a non-cancelable sublease with a remaining term of 36
months to relocate its headquarters to another facility near Research Triangle
Park, North Carolina. As described in Note 2, “Assets and Liabilities,” the
Company prepaid the lease and purchased existing furniture and fixtures for a
lump-sum payment of $500,000, of which $450,080 was allocated to rent and is
being amortized monthly over the remaining term of the lease. The Company also
had a lease through October 2009 for an apartment near its headquarters that was
utilized by its out of town executives and members of its Board of Directors.
The lease was terminated as of August 4, 2009.





On
September 4, 2009, the Company entered into a sale-leaseback agreement with the
current bondholders.  The bondholders paid a market rate cost of $200,000
through the reduction of current outstanding debt in exchange for all of the
Company’s office furniture, equipment and computers.  The bondholders then
leased all furniture, equipment and computers back to the company over a ten
(10) year period.  The monthly lease payment under the agreement is
$2,427.





Rent
expense for the nine months ended September 30, 2009 and 2008 was $129,572 and
$243,218 respectively.





Development
Agreement





In August
2005, the Company entered into a software assignment and development agreement
with the developer of a customized accounting software application. In
connection with this agreement, the developer would be paid up to $512,500 and
issued up to 32,395 shares of the Company’s common stock based upon the
developer attaining certain milestones. This agreement was modified on
March 26, 2008 to adjust the total number of shares issuable under the agreement
to 29,014. As of September 30, 2009, the Company had paid $470,834 and issued
3,473 shares of common stock related to this obligation.





Legal
Proceedings





On May
29, 2009, Dennis Michael Nouri and Reza Eric Nouri (together, the “Nouris”), a
former officer and employee of the Company, respectively, filed a complaint (the
“Nouri Complaint”) to bring a summary proceeding against the Company in the
Court of Chancery of the State of Delaware.  The Nouri Complaint sought to
compel the Company to advance legal fees and costs in the amount of $826,798
incurred by the Nouris in their defense of criminal proceedings brought against
them by the United States, and in their defense of civil proceedings brought
against them by the Securities and Exchange Commission and the Company’s
stockholders, together with future verified expenses that will be incurred by
the Nouris in defending the actions against them and the expenses incurred by
the Nouris in prosecuting the advancement action against the
Company.





On July
2, 2009, the Nouris were convicted of nine counts of criminal activity in a
federal criminal action brought against them in the United States District Court
for the Southern District of New York, and are presently awaiting
sentence.


Page
14 of 39


On July
29, 2009, the Court of Chancery granted summary judgment of the Nouri Complaint
in favor of the Nouris.  By order dated August 6, 2009, the Company is
obligated to pay to the Nouris $826,798 in advanced expenses for legal services
performed by counsel to the Nouris through April 2009.   The total
amount of the legal fees the Company will ultimately be required to advance to
the Nouris is expected to be in excess of $2.4 million. Though the Nouris have
entered into an undertaking that requires them to repay to the Company any
amounts advanced by it in the event the Nouris are ultimately determined not to
be entitled to indemnification for the expenses incurred, it is uncertain at
this time that the Company will be able to recover such amounts advanced without
considerable expense to the Company, or whether the Company will be able to
recover any of the amounts advanced at all.





On
September 24, 2009, the Nouris filed a Motion for Rule to Show Cause and the
Appointment of a Receiver in the Court of Chancery of the State of Delaware
against the Company (the “Motion”).  The Motion, among other things, seeks
the appointment of a receiver for the Company under Section 322 of the Delaware
General Corporation Law on account of the Company’s failure to pay the monetary
judgment in the amount of $826,798 entered against it by order of the Court of
Chancery on August 6, 2009 for the advancement of legal expenses incurred by the
Nouris in their defense of the foregoing criminal proceedings.  The Company
intends to vigorously contest the Motion.





Please
refer to Part I, Item 3 of our annual report on Form 10-K for the fiscal year
ending December 31, 2008 for a further description of material legal
proceedings.





5.   STOCKHOLDERS’
EQUITY





Preferred
Stock





The Board
of Directors is authorized, without further stockholder approval, subject to the
approval of the Noteholders, to issue up to 5,000,000 shares of $0.001 par value
preferred stock in one or more series and to fix the rights, preferences,
privileges, and restrictions applicable to such shares, including dividend
rights, conversion rights, terms of redemption, and liquidation preferences, and
to fix the number of shares constituting any series and the designations of such
series. There were no shares of preferred stock outstanding at September 30,
2009.





Common
Stock





The
Company is authorized to issue 45,000,000 shares of common stock, $0.001 par
value per share. As of September 30, 2009, it had 18,332,543 shares of common
stock outstanding. Holders of common stock are entitled to one vote for each
share held.





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 and
Computility.





Warrants





As
incentive to modify a letter of credit relating to the Wachovia line of credit
(see Note 3, “Notes Payable”), the Company entered into a Stock Purchase Warrant
and Agreement (the “Warrant Agreement”) with Atlas on January 15, 2007. Under
the terms of the Warrant Agreement, Atlas received a warrant containing a
provision for cashless exercise to purchase up to 444,444 shares of the
Company’s common stock at $2.70 per share at the termination of the line of
credit or if the Company is in default under the terms of the line of credit
with Wachovia. The fair value of the warrant was $734,303 as measured using the
Black-Scholes option pricing model at the time the warrant was issued. This
amount was recorded as deferred financing costs and was amortized to interest
expense in the amount of $37,657 per month over the remaining period of the
modified line of credit, which expired on August 2008. As of December 31,
2007, the deferred financing costs to be amortized to interest expense over the
remaining eight months, or $301,249, were classified as current assets. In
consideration for Atlas providing the Paragon line of credit (see Note 3, “Notes
Payable”), the Company agreed to amend the Warrant Agreement to provide that the
warrant is exercisable within 30 business days of the termination of the Paragon
line of credit or if the Company is in default under the terms of the line of
credit. If the warrant is exercised in full for cash, it will result in gross
proceeds to the Company of approximately $1.2 million.





Under a
Securities Purchase Agreement with two investors entered in connection with a
2007 private placement of the Company’s common stock, the investors were issued
warrants for the purchase of an aggregate of 1,176,471 shares of common stock at
an exercise price of $3.00 per share. These warrants contain a provision for
cashless exercise and must be exercised by February 21, 2010.





As part
of the commission paid to Canaccord Adams, Inc. (“CA”), the Company’s placement
agent in the 2007 private placement transaction, 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.





As of
September 30, 2009, warrants to purchase up to 1,655,915 shares were
outstanding.


Page
15 of 39


Equity
Compensation Plans





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





Restricted Stock – During the
first, second and third quarters of 2009, no shares of restricted stock were
issued. A total of 1,059 shares of restricted stock were canceled during the
first three quarters of 2009 due to terminations and payment of employee
tax obligations resulting from share vesting. At September 30, 2009, there was
no unvested expense yet to be recorded related to all restricted stock
outstanding.





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





The
following is a summary of the stock option activity for the six months ended
September 30, 2009:





Shares
                  
                  
                  Weighted
                    Average
                    Exercise
                    PriceBALANCE, December
      31, 2008
                  
                  
                  271,250
                  
                  
                  $
                  5.89Granted
                  
                  
                  40,000
                  
                  
                  
                  1.10Exercised
                  
                  
                  -
                  
                  
                  
                  -Canceled
                  
                  
                  (173,750
                  )
                  
                  
                  5.81BALANCE,
      September 30, 2009
                  
                  
                  137,500
                  
                  
                  $
                  4.32





The
following table summarizes information about stock options outstanding at
September 30, 2009:





Currently ExercisableExercise Price
                  
                  Number of
                    Options
                    Outstanding
                  
                  
                  Average
                    Remaining
                    Contractual
                    Life (Years)
                  
                  
                  Weighted
                    Average
                    Exercise
                    Price
                  
                  
                  Number of
                    Shares
                  
                  
                  Weighted
                    Average
                    Exercise
                    PriceFrom
      $2.50 to $3.50
                  
                  
                  85,000
                  
                  
                  
                  6.3
                  
                  
                  $
                  3.15
                  
                  
                  
                  85,000
                  
                  
                  $
                  3.14$5.00
                  
                  
                  25,000
                  
                  
                  
                  6.0
                  
                  
                  $
                  5.00
                  
                  
                  
                  25,000
                  
                  
                  $
                  5.00From
      $8.61 to $9.00
                  
                  
                  27,500
                  
                  
                  
                  6.5
                  
                  
                  $
                  8.73
                  
                  
                  
                  27,500
                  
                  
                  $
                  8.73Totals
                  
                  
                  137,500
                  
                  
                  
                  3.6
                  
                  
                  $
                  6.10
                  
                  
                  
                  137,500
                  
                  
                  $
                  6.10





At
September 30, 2009, there remains $19,469 of unvested expense yet to be recorded
related to all options outstanding.





Dividends





The
Company has not paid any cash dividends through September 30, 2009.





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:


Page
16 of 39




Three Months Ended
                    September 30, 2009Revenue Type
                  
                  Revenues
                  
                  
                  % of Total
                    Revenues(Restated)
                  
                  
                  (Restated)Customer A
                  
                  Subscription fees
                  
                  $
                  106,499
                  
                  
                  
                  36
                  %Customer
      C
                  
                  Subscription
      fees
                  
                  
                  74,465
                  
                  
                  
                  25
                  %Customer
      D
                  
                  Professional
      service fees
                  
                  
                  75,150
                  
                  
                  
                  26
                  %Customer
      E
                  
                  Professional
      service fees
                  
                  
                  37,632
                  
                  
                  
                  13
                  %Others
                  
                  Various
                  
                  
                  (96
                  )
                  
                  
                  -
                  %Total
                  
                  
                  
                  $
                  293,650
                  
                  
                  
                  100
                  %





Three Months Ended
                                September 30, 2008Revenue Type
                              
                              Revenues
                              
                              
                              % of Total
                                Revenues(Restated)
                              
                              
                              (Restated)Customer
      B
                              
                              Professional
      service fees
                              
                              
                              465,750
                              
                              
                              
                              35
                              %Customer
      C
                              
                              Subscription
      fees
                              
                              
                              213,384
                              
                              
                              
                              16
                              %Customer
      F
                              
                              Professional
      service fees
                              
                              
                              400,000
                              
                              
                              
                              30
                              %Others
                              
                              Various
                              
                              
                              253,579
                              
                              
                              
                              19
                              %Total
                              
                              
                              
                              $
                              1,332,713
                              
                              
                              
                              100
                              %





Nine Months Ended
                    September 30, 2009Revenue Type
                  
                  Revenues
                  
                  
                  % of Total
                    Revenues(Restated)
                  
                  
                  (Restated)Customer A
                  
                  Subscription
      fees
                  
                  $
                  322,314
                  
                  
                  
                  28
                  %Customer
      B
                  
                  Professional
      service fees
                  
                  
                  222,725
                  
                  
                  
                  19
                  %Customer
      C
                  
                  Subscription
      fees
                  
                  
                  291,819
                  
                  
                  
                  25
                  %Customer
      D
                  
                  Professional
      service fees
                  
                  
                  120,578
                  
                  
                  
                  11
                  %Customer
      E
                  
                  Professional
      service fees
                  
                  
                  114,328
                  
                  
                  
                  10
                  %Others
                  
                  Various
                  
                  
                  74,220
                  
                  
                  
                  7
                  %Total
                  
                  
                  
                  $
                  1,145,984
                  
                  
                  
                  100
                  %





Nine Months Ended
                    September 30, 2008Revenue Type
                  
                  Revenues
                  
                  
                  % of Total
                    Revenues(Restated)
                  
                  
                  (Restated)Customer A
                  
                  Subscription
      fees
                  
                  $
                  582,020
                  
                  
                  
                  15
                  %Customer
      B
                  
                  Professional
      service fees
                  
                  
                  1,156,854
                  
                  
                  
                  29
                  %Customer
      C
                  
                  Subscription
      fees
                  
                  
                  882,387
                  
                  
                  
                  22
                  %Customer
      D
                  
                  Professional
      service fees
                  
                  
                  398,351
                  
                  
                  
                  10
                  %Customer
      F
                  
                  Professional
      service fees
                  
                  
                  400,000
                  
                  
                  
                  10
                  %Others
                  
                  Various
                  
                  
                  569,785
                  
                  
                  
                  14
                  %Total
                  
                  
                  
                  $
                  3.989,397
                  
                  
                  
                  100
                  %





As of
September 30, 2009, two customers accounted for 62% and 38% of accounts
receivable, respectively.  As
of December 31, 2008, one customer accounted for 93% of accounts
receivable.


Page
17 of 39


7.   SUBSEQUENT EVENTS





The
information for this section has been updated through November 15,
2010.





The
Company sold convertible secured subordinated notes as follows:





Note Buyer
                                
                                Date of Purchase
                                
                                Amount of
                                  Convertible
                                  Note
                                
                                
                                Interest
                                  Rate
                                
                                
                                Original
                                  Due Date
                                
                                Restated
                                  due DateAtlas
      Capital
                                
                                October
      5, 2009
                                
                                
                                250,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2010
                                
                                11/14/2013UBP,
      Union Bancaire Privee
                                
                                October
      9, 2009
                                
                                
                                250,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2010
                                
                                11/14/2013Atlas
      Capital
                                
                                November
      6, 2009
                                
                                
                                500,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2010
                                
                                11/14/2013Atlas
      Capital
                                
                                December
      23, 2009
                                
                                
                                750,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2010
                                
                                11/14/2013Atlas
      Capital
                                
                                February
      11, 2010
                                
                                
                                500,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2010
                                
                                11/14/2013Atlas
      Capital
                                
                                April
      1, 2010
                                
                                
                                350,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2013Atlas
      Capital
                                
                                June
      2, 2010
                                
                                
                                600,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2013Atlas
      Capital
                                
                                July
      1, 2010
                                
                                
                                250,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2013Atlas
      Capital
                                
                                August
      13, 2010
                                
                                
                                100,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2013Atlas
      Capital
                                
                                August
      30, 2010
                                
                                
                                200,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2013Atlas
      Capital
                                
                                September
      14, 2010
                                
                                
                                300,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2013Atlas
      Capital
                                
                                September
      30, 2010
                                
                                
                                300,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2013Atlas
      Capital
                                
                                November
      9, 2010
                                
                                
                                300,000
                                
                                
                                
                                8
                                %
                                
                                11/14/2013





On March
5, 2010, the Company entered into the Fourth Amendment with the holders of a
majority of the aggregate outstanding principal amount of the notes issued by
the Company under the Note Purchase Agreement.  The Fourth Amendment
extends the original maturity date of the notes from November 14, 2010 to
November 14, 2013, and amends the Note Purchase Agreement, the notes and the
Registration Rights Agreement, dated November 14, 2007, to reflect this
extension.


Page
18 of 39


To fill a
vacancy in the Board, the members of the Board unanimously appointed Amir Elbaz
as a director of the Company, effective January 15, 2010, to serve until his
successor is duly elected and qualified.





Mr.
Elbaz currently advises technology and renewable energy companies on business
strategy, restructuring and business development initiatives.  Mr. Elbaz
served as the Executive Vice President & Chief Financial Officer of Lithium
Technology Corporation (“LTC”) until November 2008.  Mr. Elbaz joined LTC
in 2006 to oversee finances and marketing, as well as business
development.





On
February 25, 2010, the Company entered into a Modification Agreement with
Paragon, with an effective date of February 22, 2010, relating to the
Paragon Note, delivered by the Company to Paragon in the maximum principal
amount of $2,500,000.  The Modification Agreement (i) extended
the maturity date of the Paragon Note from February 11, 2010 to August 11,
2010, and (ii) changed the interest rate from a variable annual rate equal
to The Wall Street Journal Prime Rate, with a floor of 5.50%, to a fixed annual
rate of 6.50%.   On August 19, 2010, the Paragon Note was further
extended to October 10, 2010. Effective January 28, 2010, the expiration
date of the standby letter of credit in the amount of $2,500,000 issued by HSBC
securing the Paragon Note was extended from February 18, 2010 to
October 17, 2010 and the expiration date of the letter of credit was
subsequently extended through December 17, 2010.  We are currently
finalizing a new credit facility with a New York City based bank that we
anticipate will provide approximately $6 million of term loans that will be due
eighteen months from the date of the definitive agreements.  The loans
would be collateralized by letters of credit provided by UBS and HSBC to
the bank on behalf of Atlas.  A representative of the bank has informed us
that the bank has completed its approval process for the proposed credit
facility. The credit facility is anticipated to be available subject to
execution of definitive agreements.





On March
2, 2010, Nottingham Hall LLC, the primary landlord for the office space occupied
by the Company under a sublease between our Company and Advantis Real Estate
Services Company (Advantis), filed a Complaint in Summary Ejectment against
Advantis and our Company. The suit sought to recoup the funds not paid by
Advantis over term of the original lease between Nottingham Hall LLC and
Advantis in the sum of approximately $121,000.  Representatives for
Nottingham Hall LLC have indicated that Advantis has defaulted on the terms of
the lease and Nottingham Hall pursued our Company for the differential in rent
between our prepaid negotiated amount and the total actually due from
Advantis.





On May
11, 2010 we reached an agreement with the Nottingham Hall LLC that required the
payment of the rent differential for the period August 2009 through May 2010 and
the monthly payment of the rent differential ($4,900) for the remainder of the
lease period through September 30, 2011.  The Company entered into a lease
with the primary landlord for the remaining lease term.





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, Jesup & Lamont Securities Corp. and Sherb & Co. (our former
independent registered  accounting firm) 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 asserted violations of federal securities laws, including
violations of Section 10(b) of the Securities Exchange Act of 1934, as
amended, and Rule 10b-5. The complaint asserted 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 requested certification of the plaintiff as class
representative and seeks, among other relief, unspecified compensatory damages
including interest, plus reasonable costs and expenses including counsel fees
and expert fees. On June 24, 2008, the court entered an order appointing a lead
plaintiff for the class action. On September 8, 2008, the plaintiff filed an
amended complaint that added additional defendants who had served as directors
or officers of the Company during the class period as well as the Company’s
independent auditor.





On June
18, 2010, the Company entered into a Stipulation and Agreement of Settlement
(the "Stipulation") with the lead plaintiff in the pending securities class
action. Also included in the settlement are all the current and former officers,
directors, shareholders and employees of the Company who had also been named as
defendants in the securities class action, as well as Maxim Group. The
Stipulation provides for the settlement of the securities class action on the
terms described below. The settlement is subject to preliminary and final
approval of the United States District Court for the Middle District of North
Carolina, which the Company anticipates will occur in the fourth quarter of this
year.





The
Stipulation provides for the certification of a class consisting of all persons
who purchased the Company's publicly-traded securities between May 2, 2005 and
September 28, 2007, inclusive. The settlement class will receive total
consideration of a cash payment of $350,000 to be made by the Company, a cash
payment of $112,500 to be made by Maxim Group, the transfer from Henry Nouri to
the class of 25,000 shares of Company common stock and the issuance by the
Company to the class of 1,475,000 shares of Company common stock. Under the
terms of the Stipulation, counsel for the settlement class may sell some or all
of the common stock received in the settlement before distribution to the class,
subject to the limitation that it cannot sell more than 10,000 shares on one day
or 50,000 shares in 30 calendar days.





Once
approved, all claims against the settling defendants will be dismissed with
prejudice. The claims of the lead plaintiff against Jesup & Lamont
Securities Corp. and the Company’s former independent registered public
accounting firm, Sherb & Co., are not being dismissed and will continue. The
Stipulation contains no admission of fault or wrongdoing by the Company or the
other settling defendants.


Page
19 of 39


On June
18, 2010, the Company entered into a Settlement Agreement (the "Settlement
Agreement") with Dennis Michael Nouri, Reza Eric Nouri, Henry Nouri
and Ronna Loprete Nouri (collectively, the “Nouri Parties”). The Settlement
Agreement provides for the payment by the Company of up to $1,400,000. Of that
amount, $500,000 is payable within ten days after the date (the “Effective
Date”) of preliminary judicial approval of the class action settlement described
above (“Class Action Preliminary Judicial Approval”), and $900,000 is payable in
twelve fixed monthly installments of $75,000 commencing 60 days after the
Effective Date, with the last four scheduled installments totaling $300,000
subject to reduction to the extent that fees and disbursements for the
Nouris’ appeal are below certain levels or if the appeal is not taken to final
adjudication. The Settlement Agreement provides for the exchange of mutual
releases by the parties.





The
Settlement Agreement is contingent upon Class Action Preliminary Judicial
Approval.





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/A 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





Overview





Through
our OneBizTM platform, we develop and markets software products and services
targeted to small businesses that are delivered via a Software-as-a-Service, or
SaaS, model. We also provide website consulting and custom software development
services, primarily in the e-commerce retail and direct-selling organization
industries. We reach small businesses primarily through arrangements with
channel partners that private label our software applications and market them to
their customer bases through their corporate websites. We believe that these
relationships provide a cost and time effective process for us to market to a
diverse and fragmented yet very sizeable small-business sector.  In
addition to our channel partner strategy, we also offer our SaaS products
directly to end-user small businesses through our OneBizTM branded
website.





In the
second half of 2007, we commenced an overall evaluation of our software
development model as well as the potential applicability of currently available
development technologies. The outcome of this analysis was to develop a core
industry-standard platform for small business with an architecture designed to
integrate with a virtually unlimited number of other applications, services, and
existing infrastructures. These applications would include not only our own
small-business applications, which are currently being optimized, but also other
applications expected to arise from collaborative partnerships with third-party
developers and service providers. In addition, potential emerging-market
opportunities in the small-business segment designed to leverage social
networking and community building were identified.  Our management team
believes that, but cannot assure, this platform and associated applications will
provide opportunities for new sources of revenue, including an increase in
subscription fees. As we near completion of the development of its
industry-standard platform, as evidenced by the release of OneBizTM 1.1, in July
2009, the Company has begun increasing its emphasis on the sales and marketing
of the new platform.





In light
of our operating strategy involving the industry-standard platform, the
consolidation of all operations into our North Carolina headquarters, and other
factors including certain income tax advantages, it was concluded in the latter
part of 2008 that it was no longer necessary to operate with the Smart Commerce,
Inc. and Smart CRM, Inc. subsidiaries. As a result, an upstream merger was
completed as of December 31, 2008 that merged those subsidiaries with the parent
corporation


Page
20 of 39


Sources
of Revenue





We derive
revenues from the following sources:





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





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





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





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





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





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





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





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





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





Cost
of Revenues





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





Operating
Expenses





During
the fourth quarter of 2009, executive management intends to continue the
restructuring of the operations team that began early in the third quarter of
2009, including additions to the software development and sales and marketing
functions. The restructuring that is taking place was precipitated by the
departure of several executive management personnel in May 2009; as noted in our
public filings.





Additionally,
management is undertaking the issuance of a series of releases of our OneBiz
platform in the fourth quarter of 2009 and the first quarter of 2010. These
releases will be designed to include additional functionality and integration,
as well as to include the addition of new applications we believe will be
attractive to small businesses. The restructuring in sales and marketing is
designed to accelerate the penetration of the small company market by continuing
to enhance our channel partner marketing strategy.


Page
21 of 39


We
continue to strengthen our iMart product offering which includes the custom
design and implementation of our direct selling and network marketing customers’
complex e-commerce web sites. In addition to the typical “product purchase”
tools that are featured in most e-commerce web sites, our capability includes
such features as back office inventory management, back office multiple
commission calculations, back office affiliate rebate calculations, bar code
scanning for event management, individualized independent distributer marketing
tools including a personalized web site and unique domain ID, and back office
team management functions for “network trees”. We plan to place increased sale
and marketing emphasis on the iMart product offering.





General and
Administrative. General and administrative expenses consist of salaries
and related expenses for executive, finance and accounting, legal, human
resources, and information technology personnel; professional fees; depreciation
and amortization expenses; insurance; and other corporate expenses, including
facilities costs. We anticipate general and administrative expenses will
increase as we incur additional professional fees and insurance costs related to
the growth of our business and our operations as a public company. We expect to
continue to incur material costs in 2009 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, 2008 and Part II, Item 1, “Legal Proceedings,” in this report and
the Quarterly Reports on Form 10-Q/A for the quarterly periods ended March 31,
2009 and June 30, 2009.





Sales and Marketing.
Historically, we spent limited funds on marketing, advertising, and public
relations, particularly due to our business model of partnering with established
companies with extensive small business customer bases. In June 2008, we engaged
a public relations firm and, as a result, our public relations expenses
increased in the third quarter and will continue to do so during the fourth
quarter of 2009. As we implement our sales and marketing strategy to take our
enhanced products to market, we also expect associated costs to increase in the
balance of 2009 due to targeting new partnerships, development of channel
partner enablement programs, additional sales and marketing personnel, and the
various percentages of revenues we may be required to pay to future partners as
marketing fees.





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





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





Stock-Based Expenses. Our
operating expenses include stock-based expenses related to options, restricted
stock awards, and warrants issued to employees and non-employees. In the past,
these charges have been significant and are reflected in our historical
financial results. Effective January 1, 2006, we adopted US GAAP provisions
relating to the treatment of 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, 2008.


Page
22 of 39


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





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





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





1.
            persuasive evidence of an
      arrangement exists





2.
            delivery has
      occurred





3.
            the fee is fixed or
      determinable





4.
            collectability is
      probable





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





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





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





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





Because
our customers generally do not have the contractual right to take possession of
the software we license or market at any time, we recognize revenue on hosting
and maintenance fees as the services are provided in accordance with current US
GAAP provisions relating to arrangements that include the right to use software
stored on another entity’s hardware.


Page
23 of 39


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





Impairment of Long-Lived
Assets – We record our long-lived assets, such as property and equipment,
at cost. We review the carrying value of our long-lived assets for possible
impairment at the earlier of annually in the fourth quarter or whenever events
or changes in circumstances indicate that the carrying amount of assets may not
be recoverable as provided for in the current US GAAP relating to the accounting
for theimpairment
or disposal of long-lived assets. We measure the recoverability of assets to be
held and used by comparing the carrying amount of the asset to future net
undiscounted cash flows expected to be generated by the asset. If we consider
such assets to be impaired, we measure the impairment as the amount by which the
carrying amount exceeds the fair value, and we recognize it as an operating
expense in the period in which the determination is made.





We report
assets to be disposed of at the lower of the carrying amount or fair value less
costs to sell. Although we believe that the carrying values of our long-lived
assets are appropriately stated, changes in strategy or market conditions or
significant technological developments could significantly impact these
judgments and require adjustments to recorded asset balances.





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





Income Taxes – We are
required to estimate our income taxes in each of the jurisdictions in which we
operate. This involves estimating our current tax liabilities in each
jurisdiction, including the impact, if any, of additional taxes resulting from
tax examinations, as well as making judgments regarding our ability to realize
our deferred tax assets. Such judgments can involve complex issues and may
require an extended period to resolve. In the event we determine that we will
not be able to realize all or part of our net deferred tax assets, we would make
an adjustment in the period we make such determination. We recorded no income
tax expense in the first, second or third quarter of 2009, or in 2008 and 2007,
as we have experienced significant operating losses to date. If utilized, we may
apply the benefit of our total net operating loss carryforwards to reduce future
tax expense. Since our utilization of these deferred tax assets is dependent on
future profits, which are not assured, we have recorded a valuation allowance
equal to the net deferred tax assets. These carryforwards would also be subject
to limitations, as prescribed by applicable tax laws.





As a
result of prior equity financings and the equity issued in conjunction with
certain acquisitions, we have incurred ownership changes, as defined by
applicable tax laws. Accordingly, our use of the acquired net operating loss
carryforwards may be limited. Further, to the extent that any single-year loss
is not utilized to the full amount of the limitation, such unused loss is
carried over to subsequent years until the earlier of its utilization or the
expiration of the relevant carryforward period.





Overview
of Results of Operations for the Three Months Ended September 30, 2009 and
September 30, 2008





Total
revenues were $293,650 for the three months ended September 30, 2009 compared to
$1,332,713 for the same period in 2008, representing a decrease of $1,039,063,
or 78%. Gross profit decreased $1,060,616, or 115%, to Gross Loss ($137,317)
from Gross Profit $923,299. Operating expenses increased $102,531 or 4%, to
2,560,211 from $2,457,680. Net loss increased $1,474,718, or 106%, to $2,867,137
from $1,392,419.


Page
24 of 39


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





Three Months EndedSeptember 30,
                    2009
                  
                  
                  % of
                    Revenue
                  
                  
                  September 30,
                    2008
                  
                  
                  % of
                    Revenue(Restated)
                  
                  
                  (Restated)
                  
                  
                  (Restated)
                  
                  
                  (Restated)REVENUESSubscription
      Fees
                  
                  $
                  159,149
                  
                  
                  
                  54.2
                  %
                  
                  $
                  364,136
                  
                  
                  
                  27.3
                  %Professional
      service fees
                  
                  
                  63,200
                  
                  
                  
                  21.5
                  %
                  
                  
                  574,970
                  
                  
                  
                  43.1
                  %License
      fees
                  
                  
                  11,250
                  
                  
                  
                  3.8
                  %
                  
                  
                  291,250
                  
                  
                  
                  21.9
                  %Hosting
      Fees
                  
                  
                  33,751
                  
                  
                  
                  11.5
                  %
                  
                  
                  70,856
                  
                  
                  
                  5.3
                  %Other
      revenue
                  
                  
                  26,300
                  
                  
                  
                  9.0
                  %
                  
                  
                  31,501
                  
                  
                  
                  2.4
                  %Total
      Revenues
                  
                  
                  293,650
                  
                  
                  
                  100.0
                  %
                  
                  
                  1,332,713
                  
                  
                  
                  100.0
                  %COST
      OF REVENUES
                  
                  
                  430,967
                  
                  
                  
                  146.8
                  %
                  
                  
                  409,414
                  
                  
                  
                  30.7
                  %GROSS
      PROFIT
                  
                  
                  (137,317
                  )
                  
                  
                  -46.8
                  %
                  
                  
                  923,299
                  
                  
                  
                  69.3
                  %OPERATING
      EXPENSESGeneral
      and administrative
                  
                  
                  2,355,353
                  
                  
                  
                  802.1
                  %
                  
                  
                  1,115,398
                  
                  
                  
                  83.4
                  %Sales
      and marketing
                  
                  
                  180,759
                  
                  
                  
                  61.6
                  %
                  
                  
                  454,625
                  
                  
                  
                  34.1
                  %Research
      and development
                  
                  
                  36,406
                  
                  
                  
                  12.4
                  %
                  
                  
                  887,657
                  
                  
                  
                  66.6
                  %(Gain)/
      Loss disposal of assets
                  
                  
                  (12,307
                  )
                  
                  
                  -4.2
                  %
                  
                  
                  -
                  
                  
                  
                  0.0
                  %Total
      operating expenses
                  
                  
                  2,560,211
                  
                  
                  
                  871.9
                  %
                  
                  
                  2,457,860
                  
                  
                  
                  184.4
                  %Total
      other income (expense)Interest
      Expense (net)
                  
                  
                  (169,609
                  )
                  
                  
                  -57.7
                  %
                  
                  
                  (150,510
                  )
                  
                  
                  -11.3
                  %Gain
      on legal settlements (net)
                  
                  
                  -
                  
                  
                  
                  0.0
                  %
                  
                  
                  291,407
                  
                  
                  
                  21.9
                  %Other
      income
                  
                  
                  -
                  
                  
                  
                  0.0
                  %
                  
                  
                  1,065
                  
                  
                  
                  0.1
                  %Total
      Other Income (Expense)
                  
                  
                  (169,609
                  )
                  
                  
                  -57.7
                  %
                  
                  
                  141,962
                  
                  
                  
                  10.7
                  %NET
      LOSS
                  
                  $
                  (2,867,137
                  )
                  
                  
                  -976.4
                  %
                  
                  $
                  (1,392,419
                  )
                  
                  
                  -104.44
                  %





Comparison
of the Results of Operations for the Three Months Ended September 30, 2009 and
September 30, 2008





Revenues. Total revenues for
the three months ended September 30, 2009 were $293,650 compared to $1,332,713
for the same period in 2008, representing a decrease of $1,039,063, or 78%. This
overall decrease in revenues was primarily attributable to decreases in
subscription fees, professional service fees and license fees. Subscription Fees -
Subscription fees for the three months ended September 30, 2009 were $159,149
compared to $364,136 for the same period in 2008, representing a decrease of
$204,987, or 56%. This decrease is primarily due to a decrease in active
subscribers to whom we provide e-commerce, domain name, email services, and
related event ticket sale services for use as members of one of our primary
customers, a direct-selling organization.





Professional Service Fees -
Professional service fees for the three months ended September 30, 2009 were
$63,200 compared to $574,970 for the same period in 2008, representing a
decrease of $511,770, or 89%. This decrease is primarily due to the loss a major
customer to whom we provided professional services.





License Fees - License fees
for the three months ended September 30, 2009 were $11,250 compared to $291,250
for the same period in 2008, representing a decrease of $280,000, or 96%. This
decrease is primarily due to the fact that there were no new licenses provided
during the third quarter of 2009.





Hosting Fees – Hosting fees
for the three months ended September 30, 2009 were $33,751 compared to $70,856
for the same period in 2008, representing a decrease of $37,105, or 52%. This
decrease is primarily due to the fact that there was less hosting services
provided during the third quarter of 2009.





Other Revenue - Other revenue
for the three months ended September 30, 2009 totaled $26,300 compared to
$31,501 for the same period in 2008. This revenue is generated from non-core
activities. We expect these revenue streams to continue to be insignificant in
the future as we continue our strategy of focusing on the growth of our
subscription and license revenues.





Cost
of Revenues





Cost of
revenues for the three months ended September 30, 2009 was $430,967 compared to
$409,414 for the same period in 2008, representing an increase of $21,553, or
5%. This increase is primarily due to more domain name registrations, credit
card processing fees, and business card printing for members of our
direct-selling organization customers.


Page
25 of 39


Operating
Expenses





Operating
expenses for the three months ended September 30, 2009 were $2,560,211 compared
to $2,457,680 for the same period in 2008, representing an increase of 102,531,
or 4%. This increase was primarily attributable to the write-off of
approximately $1.8 million related to the reserve for uncollectable amounts due
from the advancement of legal fees for the defense in criminal proceedings
against Dennis Michael Nouri and Reza Eric Nouri, a former officer and employee
of the Company.  The expense is offset by a significant reduction in the
amount of research and development expense as well as the reduction of
administrative salaries and other operating expenses.




General and Administrative -
General and administrative expenses for the three months ended September 30,
2009 were $2,355,353 compared to $1,115,398 for the same period in 2008,
representing an increase of $1,239,955, or 111%. The increase was primarily
attributable to the establishment of a $1,804,763 bad-debt reserve for the
estimated uncollectable amounts due from the advancement of legal fees for the
defense in criminal proceedings against Dennis Michael Nouri and Reza Eric
Nouri, a former officer and employee of the Company. The amount of bad debt
expense for the prior period was $221,875.  The increase is offset by a
decrease in administrative salaries of $116,000, a decrease in the amount of
amortization expense of $75,000, and reduction of other administrative
expenses.





Sales and Marketing - Sales
and marketing expenses for the three months ended September 30, 2009 were
$180,759 compared to $454,625 for the same period in 2008, representing a
decrease of $273,866, or 60%. This decrease is primarily attributable to the
decrease in revenue sharing expense of $274000 with one of our primary
customers, a direct-selling organization.




Research and Development -
Research and development expenses for the three months ended September 30, 2009
were $36,406 compared to $887,657 for the same period in 2008, representing a
decrease of $851,251, or 96%. This decrease is primarily due to the fact that a
new version of the OneBiz product was released in July of 2009 and the ongoing
development expenses are now classified as part of the cost of
operations.





Other
Income (Expense)





We
incurred net interest expense of $169,609 for the three months ended September
30, 2009 compared to net interest expense of $150,510 for the same period in
2008, representing an increase of $19,099, or 13%. During the three months ended
September 30, 2009, we carried a higher balance on our line of credit with
Paragon Commercial Bank and borrowed additional funds from the bond
noteholders.





Overview
of Results of Operations for the Nine Months Ended September 30, 2009 and
September 30, 2008





Total
revenues were $1,145,984 for the nine months ended September 30, 2009 compared
to $3,989,397 for the same period in 2008, representing a decrease of
$2,843,413, or 71%. Gross profit decreased $2,200,705, or 99 %, to $20,083 from
$2,220,788. Operating expenses decreased $758,718, or 12%, to $5,776,226 from
$6,534,944. Net loss increased $1,670,466, or 37%, to $6,195,827 from
$4,525,361.





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





Nine Months EndedSeptember 30,
                      2009
                    
                    
                    % of
                      Revenue
                    
                    
                    September 30,
                      2008
                    
                    
                    % of
                      Revenue(Restated)
                    
                    
                    (Restated)
                    
                    
                    (Restated)
                    
                    
                    (Restated)REVENUESSubscription
      Fees
                    
                    $
                    610,751
                    
                    
                    
                    53.3
                    %
                    
                    $
                    1,307,934
                    
                    
                    
                    32.8
                    %Professional
      service fees
                    
                    
                    261,699
                    
                    
                    
                    22.8
                    %
                    
                    
                    2,011,497
                    
                    
                    
                    50.4
                    %License
      fees
                    
                    
                    33,750
                    
                    
                    
                    3.0
                    %
                    
                    
                    395,000
                    
                    
                    
                    9.9
                    %Hosting
      Fees
                    
                    
                    139,007
                    
                    
                    
                    12.1
                    %
                    
                    
                    166,534
                    
                    
                    
                    4.2
                    %Other
      revenue
                    
                    
                    100,777
                    
                    
                    
                    8.8
                    %
                    
                    
                    108,432
                    
                    
                    
                    2.7
                    %Total
      Revenues
                    
                    
                    1,145,984
                    
                    
                    
                    100.0
                    %
                    
                    
                    3,989,397
                    
                    
                    
                    100.0
                    %COST
      OF REVENUES
                    
                    
                    1,125,901
                    
                    
                    
                    98.2
                    %
                    
                    
                    1,768,609
                    
                    
                    
                    44.3
                    %GROSS
      PROFIT
                    
                    
                    20,083
                    
                    
                    
                    1.8
                    %
                    
                    
                    2,220,788
                    
                    
                    
                    55.7
                    %OPERATING
      EXPENSESGeneral
      and administrative
                    
                    
                    4,112,993
                    
                    
                    
                    358.9
                    %
                    
                    
                    3,456,054
                    
                    
                    
                    96.6
                    %Sales
      and marketing
                    
                    
                    707,289
                    
                    
                    
                    61.7
                    %
                    
                    
                    1,280,700
                    
                    
                    
                    32.1
                    %Research
      and development
                    
                    
                    540,232
                    
                    
                    
                    47.1
                    %
                    
                    
                    1,798,190
                    
                    
                    
                    45.1
                    %(Gain)/
      Loss disposal of assets
                    
                    
                    415,712
                    
                    
                    
                    36.3
                    %
                    
                    
                    -
                    
                    
                    
                    0.0
                    %Total
      operating expenses
                    
                    
                    5,776,226
                    
                    
                    
                    504.0
                    %
                    
                    
                    6,534,944
                    
                    
                    
                    163.8
                    %Total
      other income (expense)Interest
      Expense (net)
                    
                    
                    (455,951
                    )
                    
                    
                    -38.9
                    %
                    
                    
                    (519,746
                    )
                    
                    
                    -13.0
                    %Gain
      on legal settlements (net)
                    
                    
                    6,000
                    
                    
                    
                    0.5
                    %
                    
                    
                    291,408
                    
                    
                    
                    8.0
                    %Other
      income
                    
                    
                    10,267
                    
                    
                    
                    
                    
                    
                    
                    17,133
                    
                    
                    
                    0.4
                    %Total
      Other Income (Expense)
                    
                    
                    (439,684
                    )
                    
                    
                    -38.4
                    %
                    
                    
                    (211,205
                    )
                    
                    
                    -5.3
                    %NET
      LOSS
                    
                    $
                    (6,195,827
                    )
                    
                    
                    -540.7
                    %
                    
                    $
                    (4,525,361
                    )
                    
                    
                    -113.4
                    %


Page
26 of 39


Comparison
of the Results of Operations for the Nine Months Ended September 30, 2009 and
September 30, 2008





Revenues. Total revenues for
the nine months ended September 30, 2009 were $1,145,984 compared to
$3,989,397 for the same period in 2008, representing a decrease of
$2,843,413, or 71%. This overall decrease in revenues was primarily attributable
to a decrease in subscription and professional service fees.





Subscription Fees –
Subscription fees for the nine months ended September 30, 2009 were $610,751
compared to $1,307,934 for the same period in 2008, representing a decrease of
$697,183, or 54%. This decrease was due to a reduction in membership revenue
from a multi-level marketing organization that terminated its relationship with
our Company in June 2009.





Professional Service Fees -
Professional service fees for the nine months ended September 30, 2009 were
$261,699 compared to $2,011,497 for the same period in 2008, representing a
decrease of $1,749,798, or 87%. This decrease was due to the loss of a major
customer as reported in the report for the quarter ending June 30,
2009.





License Fees - License fees
for the nine months ended September 30, 2009 were $33,750 compared to $395,000
for the same period in 2008, representing a decrease of $361,250, or 91%. The
license revenue for the first nine months of 2008 was primarily related to a
single license agreement signed during 2007 under which $100,000 of the fee was
collected during the first quarter of 2008, but for which the revenue was
deferred at December 31, 2007 in accordance with the provisions of current US
GAAP; the ratable recognition of $30,000 of a term license that commenced in
June 2008; and the recognition of $280,000 in September 2008 relating to a
perpetual license. The license revenue for the first nine months of 2009 relates
to a single perpetual license agreement.





Hosting Fees – Hosting fees
for the nine months ended September 30, 2009 were $139,005 as compared to $
166,534 for the same period in 2008, representing a decrease of $27,529 or
17%.  The decrease relates to the reduction in hosting services required by
the customer that no longer uses our Company’s services as described in
Professional Service fees above.





Other Revenue - Other revenue
for the nine months ended September 30, 2009 totaled $100,777 compared to
$108,432 for the same period in 2008. This revenue is generated from non-core
activities. We expect these revenue streams to continue to be insignificant in
the future as we continue our strategy of focusing on the growth of our
subscription and license revenues.





Cost
of Revenues





Cost of
revenues for the nine months ended September 30, 2009 was $1,125,901 compared to
$1,768,609 for the same period in 2008, representing a decrease of $642,708, or
36%. This decrease was primarily the result of the decrease of development
personnel previously involved with the development and servicing of the major
customer that left the Company during 2009





Operating
Expenses





Operating
expenses for the nine months ended September 30, 2009 were $5,776,226 compared
to $6,534,944 for the same period in 2008, representing a decrease of $758,718,
or 11%. This decrease was primarily attributable to a decrease in research and
development expenses because the OneBiz product was released in July
2009.


Page
27 of 39


General and Administrative -
General and administrative expenses for the nine months ended September 30, 2009
were $4,112,993 compared to $3,456,054 for the same period in 2008, representing
an increase of $656,939, or 19%. The increase was primarily attributable to the
establishment of $1,804,763 bad-debt reserve for the estimated uncollectable
amounts due from the advancement of legal fees for the defense in criminal
proceedings against Dennis Michael Nouri and Reza Eric Nouri, a former officer
and employee of the Company.  The increase is offset by a decrease in
administrative salaries of $852,000, a decrease in the amount of amortization
expense of $181,000, a decrease in rent of $114,000 and reduction of other
administrative expenses.





Sales and Marketing - Sales
and marketing expenses for the nine months ended September 30, 2009 were
$707,289compared to $1,280,700 for the same period in 2008, representing a
decrease of $573,411, or 45%. The decrease is primarily attributable to $244,000
decrease in payroll and benefit expense, decrease of $51,000 in travel related
expense, decrease of $49,000  in recruiting, advertising and lead
generation costs, decrease in computer and office expenses of
$52,000,   and a decrease in revenue sharing costs with customers
of  $177,000.





Research and Development -
Research and development expenses for the nine months ended September 30, 2009
were $540,232 compared to $1,798,190 for the same period in 2008, representing a
decrease of $1,257,958, or 70%. This decrease is primarily due to the reduction
of ongoing development expense associated with the OneBiz product that was
released in July 2009.  The continuing maintenance and upgrade expense is
now treated as part of the Cost of Revenues.





Impairment of Assets and Gain
(loss) in Disposal of Assets – During the nine month period ending
September 30, 2009 the Company recognized a loss from the reduction of the value
of an intangible asset in the amount of $438,286; the amount is offset by the
gain from the sale of fixed assets during 2009.  The net result of the
transactions is $415,712.





Other
Income (Expense)





We
incurred net interest expense of $455,951 for the nine months ended September
30, 2009 compared to net interest expense of $519,746 for the same period in
2008, representing a decrease of $63,795, or 12%. Interest expense totaled
$494,582 and $562,430 and interest income totaled $38,631 and $42,684 during the
first nine months of 2008 and 2007, respectively. Interest expense decreased as
a result of the use of cash flow during the nine month period to reduce the
outstanding balance on the line of credit whenever possible.





During
the first nine months of 2009, we recognized $6,000 in other income from a gain
due to legal settlements, as compared to net gain of  $291,408 for the
gain on legal settlements with our insurance carrier as described in Note 4,
“Commitments and Contingencies,” to the consolidated financial statements in
this report.





During
the first nine months of 2009, we recognized $10,267 net gain on the sale of
assets, as compared to net gain of $17,133 for the same nine month period
in 2008,




Provision
for Income Taxes





We have
not recorded a provision for income tax expense because we have been generating
net losses. Furthermore, we have not recorded an income tax benefit for the
third quarter of 2009 primarily due to continued substantial uncertainty based
on objective evidence regarding our ability to realize our deferred tax assets,
thereby warranting a full valuation allowance in our financial statements. We
have approximately $52,000,000 in net operating loss carryforwards, which may be
utilized to offset future taxable income.





Liquidity
and Capital Resources





At
September 30, 2009, our principal sources of liquidity were cash and cash
equivalents totaling $18,749 and current accounts receivable of $10,510. As of
November 6, 2009, our principal sources of liquidity were cash and cash
equivalents totaling approximately $69,000 and accounts receivable of
approximately $19,262.  As of September 30, 2009, we had drawn
approximately $2.4 million on our $2.47 million line of credit with Paragon,
leaving approximately $70,000 available under the line of credit for our
operations. As of November 10, 2009, we had drawn approximately $2.05 million on
the Paragon line of credit, leaving approximately $420,000 available under the
line of credit for our operations, and we expect to continue to draw down on
this line of credit as needed for working capital purposes. During the third
quarter of 2008, management established automated sweeps among its accounts at
Paragon whereby all available cash at the end of each day is used to pay down
the line of credit with Paragon, the purpose of which is to reduce our interest
expense. This line of credit expires in February 2010 but is renewable if the
underlying irrevocable standby letter of credit remains in force. This letter of
credit is currently scheduled to expire in February 2010. As of November 12
2009, we also have the ability to call up to approximately $6.25 million of
additional funding from our convertible noteholders.  On each of October 5,
2009 and October 9, 2009, the Company sold a note in the principal amount of
$250,000 (total $500,000) to a current noteholder with substantially the same
terms and conditions as the previously outstanding notes.  On November 6,
2009, the Company sold a note in the principal amount of $500,000 to a current
noteholder with substantially the same terms and conditions.


Page
28 of 39


During
the quarter ended September 30, 2009, our working capital deficit increased by
approximately $1,979,000 to approximately $5,227,000 compared to a working
capital deficit of $2,989,000 at December 31, 2008. As described more fully
below, the working capital deficit at September 30, 2009 is primarily
attributable to negative cash flows from operations, including a $213,010
decrease in accounts receivable, a $3,228,038 increase in notes
receivable, and a $126,004 decrease in prepaid expenses during the first
nine months of 2009.





Cash Flow from Operations.
Cash used in operations for the nine months ended September 30, 2009 totaled
$2,703,117, down from $3,979,956 for the same period in 2008. This decrease is
primarily due to the increase in accounts payable and accrued expenses offset by
the net increase in notes receivable and the related bad debt
expense.





Cash Flow from Investing
Activities. Cash used in investing activities for the nine months ended
September 30, 2009 totaled $176,038, down from $400,238 for the same period in
2008. This decrease is primarily due to the fact that the Company acquired less
computer equipment and capitalized less software development in the first nine
months of 2009 compared to the same period in 2008.





Cash Flow from Financing
Activities. Cash provided by financing activities for the nine months
ended September 30, 2009 totaled $2,879,302, up from $937,032 for the same
period in 2008. This increase is primarily due to cash raised in 2009 from debt
borrowings to help fund operations.





Debt Financing. On February
20, 2008, the Company 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, 2010, subject to extension due to renewal, with monthly payments
being applied first to accrued interest and then to principal. The interest
shall accrue on the unpaid principal balance at the Wall Street Journal’s
published prime rate, but at no time shall the interest rate be less than 5.5%.
As of September 30, 2009, the line of credit was secured by an irrevocable
standby letter of credit in the amount of $2.5 million issued by HSBC with Atlas
as account party, expiring February 18, 2010. The Company also has 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, the Company will reimburse
Atlas any sums that Atlas is required to pay under such letter of credit. At the
Company’s 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, the Company
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 the Company is in default under the terms
of the line of credit with Wachovia. In consideration for Atlas providing the
Paragon letter of credit, the Company 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 the Company is in default under the terms of
the line of credit with Paragon.





As of
September 30, 2009, the Company had $7.85 million aggregate principal amount of
convertible secured subordinated notes due November 14, 2010 outstanding. 
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, or the initial notes. In addition, the noteholders committed
to purchase on a pro rata basis up to $5.2 million aggregate principal of
secured subordinated notes in future closings upon approval and call by our
Board of Directors. On August 12, 2008, the Company exercised its option to sell
$1.5 million aggregate principal of additional secured subordinated notes due
November 14, 2010, or the additional notes, and together with the initial notes,
the notes, with substantially the same terms and conditions as the initial
notes. In connection with the sale of the additional notes, the noteholders
holding a majority of the aggregate principal amount of the notes outstanding
agreed to increase the aggregate principal amount of secured subordinated
convertible notes that they are committed to purchase from $8.5 million to $15.3
million.  On November 21, 2008, the Company sold $500,000 aggregate
principal amount of notes, or the new notes, to two new investors with
substantially the same terms and conditions as the previously outstanding notes.
On each of January 6, 2009 and February 24, 2009, the Company sold $500,000
aggregate principal amount of notes to a current noteholder with substantially
the same terms and conditions as the previously outstanding notes. 
Additional notes with similar terms of $500,000 each were sold on April 3, 2009
and June 2, 2009.  On each of July 16, 2009, August 26, 2009, September 8,
2009, October 5, 2009 and October 9, 2009 the Company sold $250,000 aggregate
principal amount of notes to current noteholders with substantially the same
terms and conditions as the previously outstanding notes.  On November 6,
2009, the Company sold $500,000 aggregate principal amount of notes to a current
noteholder with substantially the same terms and conditions as the previously
outstanding notes.





Also on
February 24, 2009, the noteholders holding a majority of the aggregate principal
amount of the notes outstanding agreed that we may sell up to $6 million
aggregate principal amount of notes to new investors or existing noteholders at
any time on or before December 31, 2009 with a maturity date of November 14,
2010 or later. In addition, the maturity date definition for each of the notes
was changed from November 14, 2010 to the date upon which the note is due and
payable, which is the earlier of (1) November 14, 2010, (2) a change of control,
or (3) if an event of default occurs, the date upon which noteholders accelerate
the indebtedness evidenced by the notes.


Page
29 of 39


The
formula for calculating the conversion price of the notes was also amended such
that the conversion price of each outstanding note and any additional note sold
in the future would be the same and set at the lowest “applicable conversion
price,” as described below.





The
Company is obligated to pay interest on the initial notes and the additional
notes at an annualized rate of 8% payable in quarterly installments commencing
three months after the purchase date of the notes. 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 our existing stockholders
hold less than 50% of the surviving entity, or the sale of all or substantially
all of our assets, or similar transaction, or event of default, each noteholder
in its sole discretion shall have the option to:





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





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




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





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





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





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





in each
case as adjusted for stock splits, dividends or combinations, recapitalizations
or similar events.





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





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





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





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





We have
not yet achieved positive cash flows from operations, and our main sources of
funds for our operations are the sale of securities in private placements, the
sale of additional convertible notes, and bank lines of credit. We must continue
to rely on these sources until we are able to generate sufficient revenue to
fund our operations. We believe that anticipated cash flows from operations,
funds available from our existing line of credit, and additional issuances of
notes, together with cash on hand, and the anticipated extension of the due date
for the existing notes 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.


Page
30 of 39


Recent
Developments





For more
information on recent developments, see Item 1, Note 7 – “Subsequent Events”,
which is incorporated herein by reference.





Item 3.      
  Quantitative and
Qualitative Disclosures About Market Risk




Not
applicable.





Item 4.      
  Controls and
Procedures





Not
applicable.





Item 4T.     Controls and
Procedures





Evaluation
of Disclosure Controls and Procedures




As
required by Exchange Act Rules 13a-15(b) or 15d-15(b) in connection with this
Quarterly Report on Form 10-Q/A, our management, with the participation of our
interim Chief Executive Officer and interim Chief Financial Officer, evaluated
the effectiveness of our disclosure controls and procedures. The term
“disclosure controls and procedures,” as defined in Rules 13a-15(e) and
15d-15(e) under the Exchange Act, means controls and other procedures of a
company that are designed to ensure that information required to be disclosed by
a company in the reports that it files or submits under the Exchange Act is
recorded, processed, summarized and reported, within the time periods specified
in the SEC’s rules and forms. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by a company in the reports that it files or submits
under the Exchange Act is accumulated and communicated to the company’s
management, including its principal executive and principal financial officers,
as appropriate to allow timely decisions regarding required disclosure.
Management recognizes that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, as ours are designed to do.  Based on the
evaluation of our disclosure controls and procedures, our interim Chief
Executive Officer and interim Chief Financial Officer concluded that, our
disclosure controls and procedures were not effective at the reasonable
assurance level due to the material weaknesses described below, which required
us to restate our unaudited financial statements at and for the period
ended September 30, 2009.




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





·
            Review
      of our intangible asset values caused the financial statements to be
      restated. The value of the iMart trade name as of December 31, 2008 was
      restated because of a recalculation of the net royalty method of
      valuation.




Since our
evaluation of the above, we performed additional analysis and other post closing
procedures to ensure our financial statements were prepared in accordance with
generally accepted accounting principles. Accordingly, we believe that the
financial statements included in this report fairly present in all material
respects, our financial condition, results of operations and cash flows for the
periods presented.




Changes
in Internal Control Over Financial Reporting




There
were no changes in our internal control over financial reporting that occurred
during the third quarter of fiscal year 2009 that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting.




Page
31 of 39




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, 2008 and Part II, Item 1 of our Quarterly Reports on
Form 10-Q/A for the quarterly periods ended March 31, 2009 and June 30, 2009 for
a description of material legal proceedings, including the proceedings discussed
below.





As
previously reported in the Company’s Form 8-K filed on June 4, 2009, Dennis
Michael Nouri and Reza Eric Nouri (together, the “Nouris”), a former officer and
employee of the Company, respectively, filed a complaint (the “Nouri Complaint”)
to bring a summary proceeding against the Company in the Court of Chancery of
the State of Delaware.  The Nouri Complaint sought to compel the Company to
advance legal fees and costs in the amount of $826,798 incurred by the Nouris in
their defense of criminal proceedings brought against them by the United States,
and in their defense of civil proceedings brought against them by the Securities
and Exchange Commission and the Company’s stockholders, together with future
verified expenses that will be incurred by the Nouris in defending the actions
against them and the expenses incurred by the Nouris in prosecuting the
advancement action against the Company.




On July
29, 2009, the Court of Chancery granted summary judgment of the Nouri Complaint
in favor of the Nouris.  By order dated August 6, 2009, the Company is
obligated to pay to the Nouris $826,798 in advanced expenses for legal services
performed by counsel to the Nouris through April 2009.   The total
amount of the legal fees the Company will ultimately be required to advance to
the Nouris is expected to be in excess of $2.4 million, which amount has been
included in the accounts payable of the Company as of September 30, 2009. 
A current note receivable is recorded for the same amount due from the
individuals. Though the Nouris have entered into an undertaking that requires
them to repay to the Company any amounts advanced by it in the event the Nouris
are ultimately determined not to be entitled to indemnification for the expenses
incurred, it is uncertain at this time that the Company will be able to recover
such amounts advanced without considerable expense to the Company, or whether
the Company will be able to recover any of the amounts advanced at
all.





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





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. If an
unfavorable resolution of any of these matters occurs, our business, results of
operations, and financial condition could be materially adversely
affected.


Page
32 of 39


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 revolving line of credit with Paragon and convertible note
financing, and the anticipated extension of the due date for the existing notes
should fund our operations for the next 12 to 18 months. As of November 10,
2009, we have approximately $420,000 available on our line of credit and $6.25
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 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.





In
addition, our current primary credit facilities consisting of the Paragon line
of credit and the convertible note financing both have maturity dates in
February and November 2010. Should we be unable to repay the principal then due
or extend maturity dates or obtain capital from new or renegotiated capital
funding sources, we will be unable to sustain our business. As of November 10,
2009, we have approximately $2.05 million outstanding on our line of credit and
$8.5 million aggregate principal amount of convertible notes
outstanding.





Our
independent registered public accountants for fiscal 2008 indicated that they
have substantial doubts that we can continue as a going concern. Their opinion
may negatively affect our ability to raise additional funds, among other things.
If we fail to raise sufficient capital, we will not be able to implement our
business plan, we may have to liquidate our business, and you may lose your
investment.





Sherb
& Co., LLP, our independent registered public accountants for fiscal 2008,
has expressed substantial doubt in their report included with our Annual Report
on Form 10-K for the year ended December 31, 2008 about our ability to continue
as a going concern given our recurring losses from operations and deficiencies
in working capital and equity, which are described in the first risk factor
above. This opinion could materially limit our ability to raise additional funds
by issuing new debt or equity securities or otherwise. If we fail to raise
sufficient capital, we will not be able to implement our business plan, we may
have to liquidate our business, and you may lose your entire investment. You
should consider our independent registered public accountants’ comments when
determining if an investment in us is suitable.





If
we are unable to renegotiate an extension of the due date for the outstanding
bond debt, obtain conversion of the debt to preferred stock or identify
alternate financing sources, the Company will be forced to liquidate our
business.





As of
November 12, 2009, the Company has $8,950,000 of outstand debt due the
bondholders.  The current terms of the bonds indicate a due date of
November 14, 2010.  If the Company is unable to repay the amount of the
principal on the due date or unable to renegotiate an extension of the due date
for the outstanding bond debt, obtain conversion of the debt to preferred stock
or identify alternate financing sources, the Company may be forced to liquidate
our business.





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





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


Page
33 of 39


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





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




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





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





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





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





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 convertible
secured subordinated notes are secured by a first priority lien on all of our
unencumbered assets.





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





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





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


Page
34 of 39


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 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
advance legal expenses to, current and former officers, directors and employees
against claims arising out of such person’s status or activities as our officer,
director or employee from such claims 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.   Also, there is a stockholder class action lawsuit pending
against us and certain of our current and former officers, directors, and
employees. The SEC, criminal, and stockholder actions are more fully described
above under “Legal Proceedings” and in Part I, Item 3, “Legal Proceedings,” in
our Annual Report on Form 10-K for the year ended December 31,
2008..





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





As
reported in the Form 8-K filed by the Company on June 4, 2009, our insurance
coverage for advancement claims has been exhausted. As noted herein in Item 4,
“Commitments and Contingencies – Legal Proceedings”, by order dated August 6,
2009, the Company is obligated to pay to Dennis Michael Nouri and Reza Eric
Nouri $826,798 in advanced expenses for legal services performed by counsel to
the Nouris through April 2009.   The total amount of the legal fees
the Company will ultimately be required to advance to the Nouris is expected to
be in excess of $2.4 million. In addition, a number of our current and former
employees were asked to appear as witnesses in the criminal action and may
seek advancement of legal expenses from us. Payment of these amounts would
adversely impact our financial condition and results of operations, which could
result in a significant reduction in the amounts available to fund working
capital, capital expenditures, and other general corporate objectives and could
ultimately require us to file for bankruptcy.




Finally,
our insurance policies provide that, under certain conditions, our insurance
carriers may have the right to seek recovery of any amounts they paid to us or
the insured individuals.  As of November 10, 2009, we do not know and can
offer no assurances about whether these conditions will apply or whether the
insurance carriers will change their position regarding coverage related to the
current actions. Therefore, we can offer no assurances that our insurance
carriers will not seek to recover any amounts paid under their policies from us
or the individual insureds. 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 and could ultimately require us to file
for bankruptcy.


Page
35 of 39


Our
executive management team has undergone significant changes and 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 since 2008,
including the resignation of our Chief Executive Officer on December 9, 2008,
the resignation of our Chairman of the Board and Interim Chief Executive Officer
on May 19, 2009. It may be difficult to attract highly qualified candidates to
serve on our executive management team on a permanent basis. If we cannot
attract and retain qualified personnel and integrate new members of our
executive management team effectively into our business, then our business and
financial results may suffer. In addition, all of our executive team works at
the same location, which could make us vulnerable to the loss of our entire team
in the event of a natural or other disaster. We do not maintain key man
insurance policies on any of our employees.





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.





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





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.





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.


Page
36 of 39


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 November 5, 2009
there were 18,332,542 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.





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





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





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





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





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





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





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





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





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.


Page
37 of 39


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





During
the first, second and third quarter of fiscal 2009, we sold equity securities
totaling $219 and $876, respectively that were not registered under the
Securities Act, as described in our Current Reports on Form 8-K filed in
connection with such transactions.





The
following table lists all repurchases during the first and second and third
quarters of fiscal 2009 of any of our securities registered under
Section 12 of the Exchange Act by or on behalf of us or any affiliated
purchaser.





Issuer
Purchases of Equity Securities




Period
                                
                                Total
                                  Number of
                                  Shares
                                  Purchased
                                
                                
                                Average
                                  Price
                                  Paid Per
                                  Share
                                
                                
                                Total Number of
                                  Shares Purchased as
                                  Part of Publicly
                                  Announced Plans or
                                  Programs
                                
                                
                                Maximum
                                  Number of
                                  Shares That May
                                  Yet Be Purchased
                                  Under the Plans or
                                  ProgramsJanuary 1
      – January 31, 2009
                                
                                
                                -
                                
                                
                                $
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -February
      1 – February 28, 2009
                                
                                
                                -
                                
                                
                                $
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -March
      1 – March 31, 2009 (1)
                                
                                
                                146
                                
                                
                                $
                                1.50April
      1 – June 30, 2009
                                
                                
                                580
                                
                                
                                $
                                1.51
                                
                                
                                
                                -
                                
                                
                                
                                -July
      1 – September 30, 2009
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                -Total
                                
                                
                                726
                                
                                
                                $
                                1.50
                                
                                
                                
                                -
                                
                                
                                
                                -





(1)
            Represents 146 and 580 shares
      repurchased in connection with tax withholding obligations under the 2004
      Plan.





Item 6.     Exhibits





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





Exhibit No.
                    
                    Description31.1
                    
                    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.


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SIGNATURES





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





Smart
      Online, Inc./s/ Dror ZoreffDror
      ZoreffDate:
      November 16, 2010
                      Interim
      Chief Executive Officer, President and Principal Executive
      Officer/s/ Thaddeus J. ShalekThaddeus
      J. ShalekChief  Financial
      Officer andDate:
      November 16, 2010
                      Principal
      Accounting
Officer




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