**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**


**_________________**





**FORM
      10-Q**


**_________________**


**(Mark
      One)**


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





**For
      the quarterly period ended March 31, 2008**





**OR**





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





**Commission
      File Number: 001-32634**


**_________________**





**SMART
      ONLINE, INC.**


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


**_________________**





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





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





**(919)
      765-5000**


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


**_________________**





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





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





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





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





As
      of May
      12, 2008, there were approximately 18,234,627 shares of the registrant’s
      common stock, par value $0.001 per share, outstanding.








**SMART
      ONLINE, INC.**





**FORM
      10-Q**


For
      the
      Quarterly Period Ended March 31, 2008





**TABLE
      OF CONTENTS**





Page
                No.**PART
                I –
                FINANCIAL INFORMATION**Item
                1.
            Financial
                StatementsConsolidated
                Balance Sheets as of March 31, 2008 (unaudited) and December 31,
                2007
            3Consolidated
                Statements of Operations (unaudited) for the three months ended March
                31,
                2008 and 2007
            4Consolidated
                Statements of Cash Flows (unaudited) for the three months ended March
                31,
                2008 and 2007
            5Notes
                to Consolidated Financial Statements (unaudited)
            6Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            15Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            23Item
                4.
            Controls
                and Procedures
            23Item
                4T.
            Controls
                and Procedures
            23**PART
                II – OTHER INFORMATION**Item
                1.
            Legal
                Proceedings
            24Item
                1A.
            Risk
                Factors
            24Item
                2.
            Unregistered
                Sales of Equity Securities and Use of Proceeds
            31Item
                6.
            Exhibits
            31Signatures
            32


2


**PART
      I – FINANCIAL INFORMATION**





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





**SMART
      ONLINE, INC.**


**CONSOLIDATED
      BALANCE SHEETS**





**March
                31,**
              **2008**
              **(unaudited)**
            
            **December 31,**
              **2007****Assets**CURRENT
                ASSETS:Cash
                and Cash Equivalents
            
            $
            351,758
            
            $
            3,473,959Accounts
                Receivable, Net
            
            
            757,785
            
            
            815,102Current
                Portion of Note Receivable
            
            
            55,000
            
            
            55,000Prepaid
                Expenses
            
            
            131,644
            
            
            90,886Deferred
                Financing Costs (See Note 3)
            
            
            188,278
            
            
            301,249Total
                Current Assets
            
            
            1,484,465
            
            
            4,736,196PROPERTY
                AND EQUIPMENT, Net
            
            
            151,245
            
            
            174,619LONG-TERM
                PORTION OF NOTE RECEIVABLE
            
            
            225,000
            
            
            225,000INTANGIBLE
                ASSETS, Net
            
            
            2,697,401
            
            
            2,882,055GOODWILL
            
            
            2,696,642
            
            
            2,696,642OTHER
                ASSETS
            
            
            45,311
            
            
            60,311TOTAL
                ASSETS
            
            $
            7,300,064
            
            $
            10,774,823**Liabilities
                and Stockholders’ Equity**CURRENT
                LIABILITIES:Accounts
                Payable
            
            $
            543,945
            
            $
            628,370Current
                Portion of Notes Payable (See Note 4)
            
            
            507,672
            
            
            2,287,682Deferred
                Revenue (See Note 3)
            
            
            440,700
            
            
            329,805Accrued
                Liabilities (See Note 3)
            
            
            547,138
            
            
            603,338Total
                Current Liabilities
            
            
            2,039,455
            
            
            3,849,195LONG-TERM
                LIABILITIES:Long-Term
                Portion of Notes Payable (See Note 4)
            
            
            3,311,848
            
            
            3,313,903Deferred
                Revenue (See Note 3)
            
            
            16,186
            
            
            247,312Total
                Long-Term Liabilities
            
            
            3,328,034
            
            
            3,561,215Total
                Liabilities
            
            
            5,367,489
            
            
            7,410,410COMMITMENTS
                AND CONTINGENCIESSTOCKHOLDERS’
                EQUITY:Common
                Stock, $.001 Par Value, 45,000,000 Shares Authorized, Shares Issued
                and
                Outstanding:March
                31, 2008 - 18,226,008; December 31, 2007 –
                18,159,768
            
            
            18,226
            
            
            18,160Additional
                Paid-in Capital
            
            
            66,601,158
            
            
            66,202,179Accumulated
                Deficit
            
            
            (64,686,809
            )
            
            (62,855,926
            )Total
                Stockholders’ Equity
            
            
            1,932,575
            
            
            3,364,413TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            $
            7,300,064
            
            $
            10,774,823





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


3


**SMART
      ONLINE, INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS (unaudited)**




**Three Months Ended March 31,****2008**
            
            **2007**REVENUES:Subscription
                Fees
            
            $
            742,839
            
            $
            632,982Professional
                Service Fees
            
            
            555,244
            
            
            288,579License
                Fees
            
            
            100,000
            
            
            -Other
                Revenues
            
            
            24,655
            
            
            20,825Total
                Revenues
            
            
            1,422,738
            
            
            942,386COST
                OF REVENUES
            
            
            186,568
            
            
            73,826GROSS
                PROFIT
            
            
            1,236,170
            
            
            868,560OPERATING
                EXPENSES:General
                and Administrative
            
            
            1,356,016
            
            
            1,058,778Sales
                and Marketing
            
            
            674,831
            
            
            482,292Research
                and Development
            
            
            860,449
            
            
            619,999Total
                Operating Expenses
            
            
            2,891,296
            
            
            2,161,069LOSS
                FROM CONTINUING OPERATIONS
            
            
            (1,655,126
            )
            
            (1,292,509
            )OTHER
                INCOME (EXPENSE):Interest
                Expense, Net
            
            
            (178,314
            )
            
            (135,185
            )Gain
                on Debt Forgiveness
            
            
            -
            
            
            4,600Gain
                on Sale of Assets
            
            
            2,665
            
            
            -Other
                Income
            
            
            (108
            )
            
            113,330Total
                Other Income (Expense)
            
            
            (175,757
            )
            
            (17,255
            )NET
                LOSS FROM OPERATIONS
            
            
            (1,830,883
            )
            
            (1,309,764
            )NET
                LOSSATTRIBUTED
                TO COMMON STOCKHOLDERS
            
            $
            (1,830,883
            )
            $
            (1,309,764
            )NET
                LOSS PER SHARE:Basic
                and Fully Diluted
            
            $
            (0.10
            )
            $
            (0.08
            )Net
                Loss Attributed to Common StockholdersBasic
                and Fully Diluted
            
            $
            (0.10
            )
            $
            (0.08
            )SHARES
                USED IN COMPUTING NET LOSS PER SHAREBasic
                and Fully Diluted
            
            
            18,201,171
            
            
            15,772,663





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


4


**SMART
      ONLINE, INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS (unaudited)**





**Three Months Ended March 31,****2008**
            
            **2007**CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                Loss
            
            $
            (1,830,883
            )
            $
            (1,309,764
            )Adjustments
                to reconcile Net Loss to Net Cash used in Operating
                Activities:Depreciation
                and Amortization
            
            
            207,630
            
            
            209,766Amortization
                of Deferred Financing Costs
            
            
            112,971
            
            
            94,141Bad
                Debt Expense
            
            
            35,468
            
            
            -Stock
                Option and Restricted Share Compensation Expense
            
            
            170,499
            
            
            156,733Registration
                Rights Penalty
            
            
            -
            
            
            (320,632
            )Gain
                on Debt Forgiveness
            
            
            -
            
            
            (4,600
            )Gain
                on Disposal of Assets
            
            
            (2,665
            )
            
            -Changes
                in Operating Assets and Liabilities:Accounts
                Receivable
            
            
            21,849
            
            
            (36,491
            )Prepaid
                Expenses
            
            
            (40,758
            )
            
            (903
            )Other
                Assets
            
            
            15,000
            
            
            (1,760
            )Deferred
                Revenue
            
            
            (89,276
            )
            
            (51,551
            )Accounts
                Payable
            
            
            (84,425
            )
            
            (10,668
            )Accrued
                and Other Expenses
            
            
            (86,968
            )
            
            43,222Net
                Cash Used In Operating Activities
            
            $
            (1,571,558
            )
            $
            (1,232,507
            )CASH
                FLOWS FROM INVESTING ACTIVITIES:Purchases
                of Furniture and Equipment
            
            
            (9,439
            )
            
            (10,759
            )Proceeds
                from Sale of Vehicle
            
            
            12,500
            
            
            -Net
                Cash Provided By (Used In) Investing Activities
            
            $
            3,061
            
            $
            (10,759
            )CASH
                FLOWS FROM FINANCING ACTIVITIES:Repayments
                on Notes Payable
            
            
            (2,053,704
            )
            
            (1,253,957
            )Debt
                Borrowings
            
            
            500,000
            
            
            1,450,000Issuance
                of Common Stock
            
            
            -
            
            
            5,748,607Net
                Cash (Used In) Provided By Financing Activities
            
            $
            (1,553,704
            )
            $
            5,944,650NET
                INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
            
            $
            (3,122,201
            )
            $
            4,701,384CASH
                AND CASH EQUIVALENTS, BEGINNING OF PERIOD
            
            $
            3,473,959
            
            $
            326,905CASH
                AND CASH EQUIVALENTS, END OF PERIOD
            
            $
            351,758
            
            $
            5,028,289Supplemental
                Disclosures of Cash Flow Information:Cash
                Paid During the Period for:Interest
            
            $
            79,878
            
            $
            73,720Income
                Taxes
            
            $
            11,000
            
            $
            -Supplemental
                Schedule of Non-cash Financing Activities:Conversion
                of Debt to Equity
            
            $
            228,546
            
            $
            -





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


5


**Smart
      Online, Inc.**


**Consolidated
      Financial Statements - Unaudited**





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





***Description
      of Business -*** Smart
      Online, Inc. (the “Company”) was incorporated in the State of Delaware in 1993.
      The Company develops
      and markets software products and services targeted to small businesses that
      have less than 50 employees. The Company’s software products and services are
      delivered via a Software-as-a-Service (“SaaS”) model. The Company sells its SaaS
      products and services primarily through private label marketing partners. The
      Company maintains a website for potential partners containing certain corporate
      information located at www.SmartOnline.com.





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





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




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




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





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





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





***Revenue
      Recognition -*** The
      Company derives revenue from the license of software platforms along with the
      sale of associated maintenance, consulting, and application development
      services. The arrangement may include delivery in multiple-element arrangements
      if the customer purchases a combination of products and/or services. The Company
      uses the residual method pursuant to American Institute of Certified Public
      Accountants (“AICPA”) Statement of Position 97-2, *Software Revenue Recognition* (“SOP
      97-2”), as amended. This method allows the Company to recognize revenue for a
      delivered element when such element has vendor specific objective evidence
      (“VSOE”) of the fair value of the delivered element. If VSOE cannot be
      determined or maintained for an element, it could impact revenues as all or
      a
      portion of the revenue from the multiple-element arrangement may need to be
      deferred.


6





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





The
      amount of revenue to be recognized from development and consulting services
      is
      typically based on the amount of work performed within a given period. Revenue
      recognition is typically 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. Changes in estimates of progress to completion and costs to
      complete are accounted for as cumulative catch-up adjustments.




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





1.
            persuasive
                evidence of an arrangement exists





2.
            delivery
                has occurred





3.
            the
                fee is fixed or determinable





4.
            collectibility
                is probable





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




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




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





***Software
      Development Costs*** -
      Statement of Financial Accounting Standard (“SFAS”) No. 86, *Accounting for the Costs of Software to Be Sold, Leased, or Otherwise
      Marketed* ,
      requires capitalization of certain software development costs subsequent to
      the
      establishment of technological feasibility. Based on the Company’s product
      development process, technological feasibility is established upon completion
      of
      a working model. Costs related to software development incurred between
      completion of the working model and the point at which the product is ready
      for
      general release have been insignificant. During 2005, the Company acquired
      certain rights to an accounting software application that has been integrated
      with its OneBiz SM platform, but is still under development. All amounts related to the development
      and modification of this application have been expensed as research and
      development costs. The Company has not capitalized any direct or allocated
      overhead associated with the development of software products prior to general
      release.





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


7





***Advertising
      Costs*** - The
      Company expenses all advertising costs as they are incurred. The amounts charged
      to sales and marketing expense during the first quarter of 2008 and 2007 were
      $2,462 and $3,574, respectively.





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





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





In
      computing the impact of stock-based compensation expense, the fair value of
      each
      award is estimated on the date of grant based on the Black-Scholes
      options-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 impact of applying
      SFAS No. 123R approximated $170,499 and $156,733 in additional compensation
      expense during the three months ended March 31, 2008 and 2007, respectively.
      The
      first quarter 2008 amount includes $122,237 of expense related to the issuance
      of restricted stock with the remainder of the first quarter 2008 amount and
      the
      entire first quarter 2007 amount relating to expense associated with stock
      options. Such amount is included in general and administrative expenses on
      the
      statements of operations.





The
      fair
      value of option grants under the Company’s equity compensation plan and other
      stock option issuances during the three months ended March 31, 2008 and 2007
      were estimated using the Black-Scholes option-pricing model with the following
      weighted-average assumptions:





**Three Months Ended**
              **March
                31,**
              **2008**
            
            **Three Months Ended**
              **March 31,**
              **2007**Dividend
                yield
            
            
            0.00
            %
            
            0.00
            %Expected
                volatility
            
            
            63.0
            %
            
            150.00
            %Risk
                free interest rate
            
            
            3.45
            %
            
            4.56
            %Expected
                lives (years)
            
            
            3.1
            
            
            4.6





The
      expected lives of the options represents the estimated period of time until
      exercise or forfeiture and is based on historical experience of similar awards.
      Expected volatility is based on the historical volatility of the Company’s
      common stock over a period of time. The risk free interest rate is based on
      the
      published yield available on U.S. treasury issues with an equivalent term
      remaining equal to the expected life of the option.





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


8


The
      following is a summary of the stock option activity for the three months ended
      March 31, 2008:





**Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**BALANCE,
                December 31, 2007
            
            
            1,644,300
            
            $
            5.07Granted
            
            
            -
            
            
            -Forfeited
            
            
            (794,600
            )
            
            6.05Exercised
            
            
            (69,930
            )
            
            1.43BALANCE,
                March 31, 2008
            
            
            779,770
            
            
            4.27





**Recently
      Issued Accounting Pronouncements**





In
      March
      2008, the Financial Accounting Standards Board issued SFAS No.
      161, *Disclosures
      about Derivative Instruments and Hedging Activities* (“SFAS
      No. 161”), which amends and expands the disclosure requirements of SFAS No. 133, *Accounting
      for Derivative Instruments and Hedging Activities,* with the
      intent to provide users of financial statements with an enhanced understanding
      of how and why an entity uses derivative instruments, how the derivative
      instruments and the related hedged items are accounted for, and how the related
      hedged items affect an entity’s financial position, performance, and cash flows.
      SFAS No. 161 is effective for financial statements for fiscal years and interim
      periods beginning after November 15, 2008. Management believes that SFAS No.
      161
      will have no impact on the financial statements of the Company once
      adopted.





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





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





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




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





***Accounts
      Receivable, Net***





The
      Company evaluates the need for an allowance for doubtful accounts based on
      specifically identified amounts that management believes to be uncollectible.
      Management also records an additional allowance based on management’s assessment
      of the general financial conditions affecting its customer base. If actual
      collections experience changes, revisions to the allowance may be required.
      Based on these criteria, management determined that no allowance for doubtful
      accounts was required as of December 31, 2007, and management has recorded
      an
      allowance of $35,000 as of March 31, 2008.


9





***Deferred
      Financing Costs***





To
      assist
      the Company in securing a modification to its line of credit with
      Wachovia Bank, NA (“Wachovia”), Atlas Capital, SA (“Atlas”) provided Wachovia
      with a stand-by letter of credit. In exchange for Atlas providing Wachovia
      with
      the modified letter of credit, the Company issued Atlas a warrant to purchase
      444,444 shares of common stock at $2.70 per share. The fair value of that
      warrant was $734,303 as measured using the Black-Scholes option-pricing model
      at
      the time the warrant was issued. Such amount was recorded as deferred financing
      costs and is being amortized to interest expense in the amount of $37,657 per
      month over the remaining period of the modified line of credit, which is
      scheduled to expire in August 2008. In January 2008, the Wachovia line of credit
      was replaced by a new line of credit with Paragon Commercial Bank (“Paragon”) as
      described in Note 4, “Notes Payable”.  Atlas agreed to provide Paragon a
      new stand-by letter of credit and the Company agreed to amend the Atlas warrant
      agreement to provide that the warrant is exercisable within 30 business days
      of
      the termination of the Paragon line of credit or if the Company is in
      default under the terms of the line of credit with Paragon. As of March 31,
      2008, the deferred financing costs that will be amortized to interest expense
      over the next twelve months totaling $188,278 were classified as current
      assets.





***Accrued
      Liabilities***





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





At
      March
      31, 2008, total accrued liabilities totaled $547,138. This amount consisted
      primarily of the above noted $204,000 liability accrued related to the
      development of the Company’s custom accounting application, $137,500 related to
      legal reserves (see Note 7, “Commitments and Contingencies”), and $94,000 of
      accrued severance related to terminations and resignations that occurred during
      the first quarter of fiscal 2008.





***Deferred
      Revenue***





At
      December 31, 2007, deferred revenue consisted of the short-term and long-term
      portion of cash received related to one or two year subscriptions for domain
      names and/or email accounts in the amount of $197,118. At March 31, 2008,
      deferred revenue consisted of the same domain name and email types of deferred
      revenue in the amount of $176,886. In addition, at December 31, 2007, the
      Company had deferred $380,000 of perpetual licensing revenue related to two
      customers that did not meet all the criteria of SOP 97-2. At March 31, 2008,
      the
      Company had deferred $280,000 of perpetual licensing revenue related to a single
      customer that did not meet all the criteria of SOP 97-2. Such deferred revenue
      will be recognized as cash is received or collectibility becomes probable.





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





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





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





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


10





As
      of
      March 31, 2008, the Company had notes payable totaling $3,819,520. The detail
      of
      these notes is as follows:





**Note Description**
            
            **Short-Term**
              **Portion**
            
            **Long-Term**
              **Portion**
            
            **TOTAL**
            
            **Maturity**
            
            **Rate**Paragon
                Commercial Bank Credit Line
            
            $
            500,000
            
            $
            -
            
            $
            500,000
            
            
            Feb
                ‘09
            
            
            Prime –0.5
            %Ailco
                Financial
            
            
            7,672
            
            
            11,848
            
            
            19,520
            
            
            June
                ‘10
            
            
            18
            %Convertible
                Notes
            
            
            -
            
            
            3,300,000
            
            
            3,300,000
            
            
            Nov
                ‘10
            
            
            8.0
            %TOTAL
            
            $
            507,672
            
            $
            3,311,848
            
            $
            3,819,520


11


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




***Common
      Stock***




During
      the three months ended March 31, 2008, 32,000 shares of restricted stock were
      issued to the newly appointed Chief Operating Officer. Restrictions lapse as
      to
      16,000 shares on April 1, 2010, 8,000 shares on April 1, 2011, and 8,000 shares
      on April 1, 2012. The Chief Operating Officer received an additional 3,000
      shares of restricted stock that had been previously promised to him in
      connection with his initial hiring in an offer letter in August 2007.
      Restrictions on these shares lapse as to 750 shares on March 19, 2008, and
      as to
      375 shares on each of June 5, 2008, September 5, 2008, December 5, 2008, March
      5, 2009, June 5, 2009, and September 5, 2009. During the first quarter of 2008
      and in conjunction with their termination of employment, the Company accelerated
      vesting with respect to 31,250 shares of restricted stock previously issued
      to
      the Company’s former Chief Financial Officer, former Chief Operating Officer,
      and former in-house legal counsel. The Company recorded $92,281 of expense
      related to the accelerated vesting of these shares including $31,500 that had
      been accrued during the fourth quarter of 2007. Additionally, net of the
      accelerated vesting discussed above, 38,458 ****** shares
      of
      restricted stock were accounted for as forfeited during the first quarter of
      2008 due to resignations and terminations. The forfeited shares included 15,625
      shares issued to the former Chief Operating Officer, 10,000 shares issued to
      the
      former Chief Financial Officer, 7,500 shares issued to a former director, and
      5,333 shares issued to former employees.





In
      a
      transaction that closed on February 21, 2007, the Company sold an aggregate
      of
      2,352,941 shares of its common stock to two new investors (the “Investors”). The
      private placement shares were sold at $2.55 per share pursuant to a Securities
      Purchase Agreement (the “SPA”) between the Company and each of the Investors.
      The aggregate gross proceeds to the Company were $6 million, and the Company
      has
      incurred issuance costs of approximately $585,000. Under the SPA, the Company
      issued the Investors warrants for the purchase of an aggregate of 1,176,471
      shares of common stock at an exercise price of $3.00 per share. These warrants
      contain a provision for cashless exercise and must be exercised, if at all,
      by
      February 21, 2010.




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





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


12





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





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





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




***Equity
      Compensation Plans***




In
      June
      2007, the Company limited the issuance of shares of its common stock reserved
      under the 2004 Equity Compensation Plan to awards of restricted or unrestricted
      stock. As such there were no issuance of options to purchase common stock during
      the first quarter of 2008. In January 2008, a former officer of the Company
      exercised options to purchase 69,930 shares of the Company’s common stock in a
      cashless exercise whereby the former officer tendered to the Company 38,462
      shares of common stock previously held by the former officer. Additionally,
      during the quarter options to purchase 794,600 shares of commons stock at prices
      ranging from $1.43 to $9.82 were forfeited by former employees, officers,
      directors, and consultants of the Company.





The
      following table summarizes information about stock options outstanding at March
      31, 2008:





**Currently Exercisable****Exercise**
              **Price**
            
            **Number of**
              **Shares**
              **Outstanding**
            
            **Average**
              **Remaining**
              **Contractual Life**
              **(Years)**
            
            **Weighted**
              **Average Exercise**
              **Price**
            
            **Number of**
              **Shares**
            
            **Weighted**
              **Average**
              **Exercise**
              **Price**From
                $1.30 to $1.43
            
            
            255,070
            
            
            0.4
            
            $
            1.39
            
            
            255,070
            
            $
            1.39From
                $2.50 to $3.50
            
            
            235,000
            
            
            2.0
            
            $
            3.33
            
            
            227,000
            
            $
            3.33$5.00
            
            
            31,400
            
            
            7.0
            
            $
            5.00
            
            
            16,400
            
            $
            5.00$7.00
            
            
            75,000
            
            
            7.5
            
            $
            7.00
            
            
            75,000
            
            $
            7.00From
                $8.61 to $9.00
            
            
            183,100
            
            
            5.8
            
            $
            8.75
            
            
            98,800
            
            $
            8.72$9.60
            
            
            200
            
            
            7.5
            
            $
            9.60
            
            
            80
            
            $
            9.60





***Dividends***





The
      Company has not paid any cash dividends through March 31, 2008.


13


**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:





Three
                Months Ended
              March
                31, 2008Revenues
            
            % of Total
              RevenuesCustomer
                A
            
            
            Professional
                Services Fee
            
            $
            300,884
            
            
            21
            %Customer
                B
            
            
            Subscription
            
            
            361,090
            
            
            25
            %Customer
                C
            
            
            Subscription
            
            
            216,283
            
            
            15
            %Customer
                D
            
            
            Professional
                Service Fees
            
            
            383,191
            
            
            27
            %Others
            
            
            Various
            
            
            161,290
            
            
            12
            %Total
            
            
            
            
            $
            1,422,738
            
            
            100
            %




Three
                Months Ended
              March
                31, 2007Revenues
            
            % of Total
              RevenuesCustomer
                B
            
            
            Subscription
            
            $
            311,984
            
            
            33
            %Customer
                D
            
            
            Professional
                Service Fees
            
            
            182,077
            
            
            19
            %Others
            
            
            Various
            
            
            448,325
            
            
            48
            %Total
            
            
            
            
            $
            942,386
            
            
            100
            %





As
      of
      March 31, 2008, the Company had three customers that accounted for 38%, 25%,
      and
      20% of net receivables, respectively. As of December 31, 2007, the Company
      had
      three customers that accounted for 42%, 28% and 17% of net receivables,
      respectively.





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





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





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





In
      August
      2005, the Company entered into a software assignment and development agreement
      with the developer of a customized accounting software application.  In
      connection with this agreement, the developer would be paid up to $512,500
      and
      issued up to 32,395 shares of the Company common stock based upon the developer
      attaining certain milestones.  As of March 31, 2008, the Company had
      paid $387,500 and issued 3,473 shares of common stock related to this
      obligation.





On
      October 17, 2007, Henry Nouri, the Company’s former Executive Vice President,
      filed a civil action against the Company in the General Court of Justice,
      Superior Court Division, in Orange County, North Carolina. The complaint alleged
      that the Company had no “cause” to terminate Mr. Nouri’s employment and that it
      breached Mr. Nouri’s employment agreement by notifying him that his employment
      was terminated for cause, by failing to itemize the cause for the termination,
      and by failing to pay him benefits to which he would have been entitled had
      his
      employment been terminated without “cause.” The complaint sought unspecified
      compensatory damages, including interest, a declaratory judgment that no cause
      existed for the termination of Mr. Nouri’s employment and that Mr. Nouri is
      entitled to the benefits provided under his employment agreement for a
      termination without “cause,” and costs and expenses. On December 17, 2007, Mr.
      Nouri served his First Amended Complaint in which he, among other things, added
      an allegation that he was entitled to additional relief because of an alleged
      “beneficial change of ownership” in the Company. On January 23, 2008, the
      parties settled this dispute, and on January 24, 2008, the lawsuit was dismissed
      with prejudice.


14





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





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





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





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





*Information
      set forth in this Quarterly Report on Form 10-Q contains various forward-looking
      statements within the meaning of Section 27A of the Securities Act of 1933,
      or
      the Securities Act, and Section 21E of the Securities Exchange Act of 1934,
      or
      the Exchange Act. Forward-looking statements consist of, among other things,
      trend analyses, statements regarding future events, future financial
      performance, our plan to build our business and the related expenses, our
      anticipated growth, trends in our business, the effect of interest rate
      fluctuations on our business, the potential impact of current litigation or
      any
      future litigation, the potential availability of tax assets in the future and
      related matters, and the sufficiency of our capital resources, all of which
      are
      based on current expectations, estimates, and forecasts, and the beliefs and
      assumptions of our management. Words such as “expect,” “anticipate,” “project,”
“intend,” “plan,” “estimate,” variations of such words, and similar expressions
      also are intended to identify such forward-looking statements. These
      forward-looking statements are subject to risks, uncertainties, and assumptions
      that are difficult to predict. Therefore, actual results may differ materially
      and adversely from those expressed in any forward-looking statements. Readers
      are directed to risks and uncertainties identified under Part II, Item 1A,
“Risk
      Factors,” and elsewhere in this report, for factors that may cause actual
      results to be different than those expressed in these forward-looking
      statements. Except as required by law, we undertake no obligation to revise
      or
      update publicly any forward-looking statements for any reason.*





**Overview**





We
      develop and market software products and services delivered via a
      Software-as-a-Service, or SaaS, model and targeted to small businesses that
      have
      less than 50 employees. We reach small businesses primarily through arrangements
      with large corporations that private-label our software applications through
      their corporate websites. We believe these relationships provide a cost and
      time
      efficient way to market to a diverse, fragmented, yet very sizeable small
      business sector.




Prior
      to
      2008, we operated our company as two segments. During late 2007 and the first
      quarter of 2008, management realigned certain production and development
      functions and eliminated redundant administrative functions and now manages
      the
      consolidated business as a single business segment.





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


15





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





Total
      revenues were $1,423,000 for the first quarter of 2008 compared to $942,000
      for
      the first quarter of 2007, representing an increase of $481,000, or 51%. Gross
      profit increased $367,000, or 42%, to $1,236,000 from $869,000. Operating
      expenses increased $730,000, or 34%, to $2,891,000 from $2,161,000. Net loss
      grew to $1,831,000 from $1,310,000, an increase of $521,000, or 40%.





**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 licensing of platforms or applications.
                Licenses may be perpetual or for a specific
                term.




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




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




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





Subscription
      revenues primarily consist of sales of subscriptions through private label
      marketing partners to end users, sales of subscriptions directly to end users,
      hosting and maintenance fees, and e-commerce website design fees. We typically
      have a revenue share arrangement with these private label marketing partners
      in
      order to encourage them to market our products and services to their customers.
      We make subscription sales either on a subscription or on a “for fee” basis.
      Applications for which subscriptions are available vary from our own portal
      to
      the websites of our partners. Subscriptions are generally payable in advance
      on
      a monthly basis and are typically paid via credit card of the individual end
      user or their aggregating entity. Our subscription revenue has increased by
      17%
      from the first quarter of 2007 to the first quarter of 2008 based on our ability
      to secure new private label partners in the direct selling industry. We are
      focusing our efforts on signing up new channel partners as well as diversifying
      with vertical intermediaries in various industries.





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





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





Other
      revenues primarily consist of non-core revenue sources such as traditional
      shrink-wrap software sales, miscellaneous web services, and OEM revenue
      generated through sales of our applications bundled with products offered by
      other manufacturers. It also includes syndication and integration fees, which
      historically have been presented separately in our statements of operations.
      As
      we have shifted our focus toward driving subscription revenue, which we deem
      to
      have the greatest potential for future revenue growth, we have seen a decrease
      in syndication and integration revenue from historic levels. Therefore, these
      fees are now reported under other revenues.


16





**Cost
      of Revenues**





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





**Operating
      Expenses**





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





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





*Sales
      and Marketing* .
      Historically, we spent limited funds on marketing, advertising, and public
      relations. Our business model of partnering with established companies with
      extensive small business customer bases allows us to leverage the marketing
      dollars spent by our partners rather than requiring us to incur such costs.
      We
      expect sales and marketing expense to increase due to new partnerships targeted
      to come online in the second and third quarters of 2008 and the various
      percentages of revenue we may be required to pay to future partners as marketing
      fees.





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





*Stock-Based
      Expenses* .
      Our
      operating expenses include stock-based expenses related to options, restricted
      stock awards, and warrants issued to employees and non-employees. These charges
      have been significant and are reflected in our historical financial results.
      Effective January 1, 2006, we adopted SFAS No. 123 (revised
      2004), “Share-Based Payment,” or SFAS No. 123R, 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 and do not anticipate
      any further stock option awards to be granted under the 2004 Plan.


17





**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 re-evaluate our critical
      accounting policies and estimates, including those related to revenue
      recognition, provision for doubtful accounts and sales returns, expected lives
      of customer relationships, useful lives of intangible assets and property and
      equipment, provision for income taxes, valuation of deferred tax assets and
      liabilities, and contingencies and litigation reserves. Management has
      consistently applied the same critical accounting policies and estimates which
      are fully described in our Annual Report on Form 10-K for the year ended
      December 31, 2007.





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





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





We
      typically base the amount of revenue to be recognized from development and
      consulting services on the amount of work performed within a given period.
      Revenue recognition is typically 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. We account for changes in estimates of progress to
      completion and costs to complete as cumulative catch-up
      adjustments.





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





1.
            persuasive
                evidence of an arrangement exists


2.
            delivery
                has occurred


3.
            the
                fee is fixed or determinable


4.
            collectibility
                is probable





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


18





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





**Overview
      of Results of Operations for the Three Months Ended March 31, 2008 and March
      31,
      2007**





Total
      revenues were $1,423,000 for the first quarter of 2008 compared to $942,000
      for
      the first quarter of 2007, representing an increase of $481,000, or 51%. Gross
      profit increased $367,000, or 42%, to $1,236,000 from $869,000. Operating
      expenses increased $730,000, or 34%, to $2,891,000 from $2,161,000. Net loss
      grew to $1,831,000 from $1,310,000, an increase of $521,000, or 40%.





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





**Three Months**
              **Ended**
              **March 31,**
              **2008**
            
            **Three Months**
              **Ended**
              **March 31,**
              **2007**REVENUES:Subscription
                Fees
            
            
            52
            %
            
            67
            %Professional
                Service Fees
            
            
            39
            %
            
            31
            %License
                Fees
            
            
            7
            %
            
            0
            %Other
                Revenues
            
            
            2
            %
            
            2
            %Total
                Revenues
            
            
            100
            %
            
            100
            %COST
                OF REVENUES
            
            
            13
            %
            
            8
            %GROSS
                PROFIT
            
            
            87
            %
            
            92
            %OPERATING
                EXPENSES:General
                and Administrative
            
            
            95
            %
            
            112
            %Sales
                and Marketing
            
            
            47
            %
            
            51
            %Research
                and Development
            
            
            61
            %
            
            66
            %Total
                Operating Expenses
            
            
            203
            %
            
            229
            %LOSS
                FROM OPERATIONS
            
            
            (116
            )%
            
            (137
            )%OTHER
                INCOME (EXPENSE):Interest
                Income (Expense), Net
            
            
            (13
            )%
            
            (14
            )%Gain
                on Debt Forgiveness
            
            
            0
            %
            
            0
            %Other
                Income
            
            
            0
            %
            
            12
            %Gain
                on Sale of Assets
            
            
            0
            %
            
            0
            %Total
                Other Income (Expense)
            
            
            (13
            )%
            
            (2
            )%NET
                INCOME (LOSS)
            
            
            (129
            )%
            
            (139
            )%


19





**Comparison
      of the Results of Operations for the Three Months Ended March 31, 2008 and
      March
      31, 2007**





**Revenues**





Total
      revenues were $1,423,000 for the first quarter of 2008 compared to $942,000
      for
      the first quarter of 2007 representing an increase of $481,000, or 51%. This
      increase is attributable to increases in subscription revenues, professional
      service fees, and licensing fees totaling $110,000, $266,000, and $100,000,
      respectively. These increases were due to new customers signed after the first
      quarter of 2007 as well as increased revenue from existing customers.





Subscription
      revenues increased $110,000, or 17%, to $743,000 for the first quarter of 2008
      from $633,000 for the first quarter of 2007. This increase was due to new
      partnerships under which we began recognizing revenue in the second half of
      2007.





Revenues
      from professional service fees increased $266,000, or 92%, to $555,000 for
      the
      first quarter of 2008 from $289,000 for the first quarter of 2007. This increase
      was due to existing customers requesting additional consulting services for
      their web initiatives. Professional service fees accounted for approximately
      39%
      of first quarter 2008 revenues as compared to approximately 30% for both the
      first quarter of 2007 and fiscal year 2007. Management expects that professional
      service fees will continue to represent a greater portion of total revenues
      for
      fiscal 2008 as compared to fiscal 2007.





License
      fees totaled $100,000 during the first quarter of 2008 compared to $0 for the
      same period in 2007. The first quarter 2008 revenue related to a single license
      agreement signed during 2007 under which $100,000 of the fee was collected
      during the first quarter of 2008. This revenue was deferred at December 31,
      2007
      in accordance with the provisions of SOP 97-2. The timing and amount of future
      license revenues is dependent upon our ability to sign new licensing agreements
      and the revenue recognition criteria outlined in SOP 97-2.





Other
      revenues totaled $25,000 and $21,000 for the quarters ended March 31, 2008
      and
      2007, respectively. This revenue is generated from a single residual agreement
      and non-core activities such as sales of shrink-wrapped products, OEM contracts,
      and miscellaneous other revenues. We expect these revenue streams to continue
      to
      be insignificant in the future as we continue our strategy of focusing on growth
      of our subscription and license revenues.





**Cost
      of Revenues**





Cost
      of
      revenues increased $113,000, or 153%, to $187,000 in the first quarter of 2008
      from $74,000 in the first quarter of 2007. This increase was primarily a result
      of increased hosting costs related to hosting for additional customers, which
      resulted in an increase in cost of revenues of approximately $29,000, an
      increase in personnel costs of approximately $45,000 related to the addition
      of
      several employees in our customer call center during later periods of 2007,
      and
      a $12,000 increase in domain name registrations.


20


**Operating
      Expenses**





Operating
      expenses increased $730,000, or 34%, to $2,891,000 for the first quarter of
      2008
      from $2,161,000 during the first quarter of 2007. This increase is due to an
      increase in general and administrative expenses of approximately $243,000,
      an
      increase in sales and marketing expense of approximately $206,000, and an
      increase in research and development expenses of approximately
      $283,000.




*General
      and Administrative* -
      General and administrative expenses increased by $297,000, or 28%,
      to $1,356,000 for the first quarter of 2008 from $1,059,000 for the first
      quarter of 2007. This increase was primarily due to increases in payroll
      compensation expense, legal fees, and expense associated with the issuance
      and
      vesting of stock options and restricted stock. Payroll compensation expense
      increased by $73,000, including approximately $34,000 of accrued severance
      obligations payable to a former officer. Additionally, compensation expense
      required by SFAS No. 123R increased by $14,000 from the prior period as a result
      of expense associated with the accelerated vesting of certain restricted stock
      awards held by certain former officers whose employment terminated during the
      first quarter of 2008. In addition, we recorded $35,000 for bad debt expense
      for
      the first quarter of 2008 compared to zero for the first quarter of 2007 related
      to management’s judgment on collectibility of doubtful accounts. Legal and
      professional fees increased by approximately $152,000 over the corresponding
      period in 2007 due to the legal fees incurred in connection with the legal
      proceedings brought during the third quarter of 2007 against us, our former
      executive officer and a former employee.





*Sales
      and Marketing* - Sales
      and marketing expense increased to $675,000 in the first quarter of 2008 from
      $482,000 in the first quarter of 2007, an increase of $193,000, or
      40%. ****** This
      increase was primarily attributable to expense associated with revenue sharing
      arrangements, which increased by $263,000 from the first quarter of 2007. This
      increase was offset in part by a $38,000 reduction in salaries and wages
      associated with the departure of two sales executives at our Smart Commerce
      subsidiary.





*Research
      and Development* -
      Research and development expense increased to $860,000 in the first quarter
      of
      2008 from $620,000 in the first quarter of 2007, an increase of approximately
      $240,000, or 39%. This increase is due primarily to increased personnel expenses
      as we added research and development personnel during the last quarter of 2007
      and first quarter of 2008 to enhance and customize our platforms and
      applications and launch additional private label sites.





**Other
      Income (Expense)**





We
      incurred net interest expense of $178,000 during the first quarter of 2008
      compared to $135,000 during the first quarter of 2007, an increase of
      approximately $43,000, or 32%. Interest expense increased as a direct result
      of
      increased indebtedness under lines of credit and $3.3 million of secured
      subordinated convertible notes issued in November 2007. The convertible notes
      bear interest at 8% payable in quarterly installments that commenced on February
      14, 2008.





During
      the first quarter of 2007, the Company recognized $113,000 of other income
      including an $86,000 adjustment to registration rights penalties previously
      expensed during 2006.




**Provision
      for Income Taxes**





We
      have
      not recorded a provision for income tax expense because we have been generating
      net losses. Furthermore, we have not recorded an income tax benefit for the
      first quarter of 2008 primarily due to continued substantial uncertainty
      regarding our ability to realize our deferred tax assets. Based upon available
      objective evidence, there has been sufficient uncertainty regarding the ability
      to realize our deferred tax assets, which warrants a full valuation allowance
      in
      our financial statements. We have approximately $45,000,000 in net operating
      loss carryforwards, which may be utilized to offset future taxable
      income.





**Liquidity
      and Capital Resources**





At
      March
      31, 2008, our principal sources of liquidity were cash and cash equivalents
      totaling $352,000 and accounts receivable of $758,000. As of May 12, 2008,
      our
      principal sources of liquidity were cash and cash equivalents totaling
      approximately $506,000 and accounts receivable of approximately
      $861,000. ****** As of
      March 31, 2008, we have drawn approximately $500,000 of our $2.47 million line
      of credit with Paragon Commercial Bank, or Paragon, leaving approximately $1.97
      million available under the line of credit for our operations. After the end
      of
      the first quarter of 2008, we drew down an additional $900,000 from the Paragon
      line of credit, leaving approximately $1 million available under the line of
      credit for our operations, and we expect to continue to draw down on this line
      of credit as needed for working capital purposes. This line of credit expires
      in
      February 2009. We also have the ability to call up to approximately $5.2 million
      of additional funding from our convertible noteholders.


21





At
      March
      31, 2008, we had a working capital deficit of approximately
      $520,000.





**Cash
      Flow from Operations** .
      Cash
      flows used in operations for the three months ended March 31, 2008 totaled
      $1,572,000, up from $1,233,000 for the three months ended March 31, 2007. This
      increase is primarily due to paying down outstanding trade accounts payable,
      a
      legal settlement with a former employee, severance costs, new employee hires,
      and accrued liabilities.





**Cash
      Flow from Financing Activity** .
      For the
      three months ended March 31, 2008, we utilized approximately $1,554,000 net
      cash
      in financing activities to retire a line of credit as discussed below. During
      the first quarter of 2007, we generated $5.9 million of net cash from financing
      activities primarily through both debt and equity financing.





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





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





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





We
      have
      not yet achieved positive cash flows from operations, and our main sources
      of
      funds for our operations are the sale of securities in private placements,
      the
      sale of additional convertible notes, and bank lines of credit. We must continue
      to rely on these sources until we are able to generate sufficient revenue to
      fund our operations. We believe that anticipated cash flows from operations,
      funds available from our existing line of credit, and additional issuances
      of
      notes, together with cash on hand, will provide sufficient funds to finance
      our
      operations at least for the next 12 to 18 months, depending on our ability
      to
      achieve strategic goals outlined in our annual operating budget approved by
      the
      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.


22


**Recent
      Developments**





During
      April 2008, we received approximately $95,000 in insurance reimbursement for
      previously disputed legal expenses primarily related to previously disclosed
      Securities and Exchange Commission, or SEC, matters. Additional legal
      expenses related to our securities litigation matters are
      currently being reviewed by the insurance carrier. We
      contend that these legal expenses should be reimbursed by our insurance carrier.
      Because the outcome of this dispute is unclear, we have expensed all legal
      costs
      incurred with respect to the SEC matters and our internal investigation, and
      we
      will account for any insurance reimbursement, should there be any, in the period
      such amounts are reimbursed.





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




Not
      applicable.





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





Not
      applicable.





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





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





Our
      management, with the participation of our Chief Executive Officer and Interim
      Chief Financial Officer, has evaluated the effectiveness of our disclosure
      controls and procedures as of the end of the period covered by this Quarterly
      Report on Form 10-Q. Based on such evaluation, our Chief Executive Officer
      and
      Interim Chief Financial Officer concluded that, as of the end of the period
      covered by this Quarterly Report on Form 10-Q, our disclosure controls and
      procedures were not effective to insure that information required to be
      disclosed by us in the reports we file under the Exchange Act is recorded,
      processed, summarized and reported within the time periods specified in the
      SEC’s rules and forms. We have discovered errors in the historical weighted
      average earnings per share calculations and in the process for documenting
      outstanding stock options and restricted stock awards and releasing restrictions
      on restricted stock, which had an immaterial impact. We are working with outside
      counsel and a third party accounting consultant to correct these errors and
      implement proper procedures and documentation going forward.





There
      have been no changes in our internal control over financial reporting that
      occurred during the first quarter of fiscal 2008 that have materially affected,
      or are reasonably likely to materially affect, our internal control over
      financial reporting. As
      part
      of our ongoing efforts to improve our internal control over financial reporting,
      we are restructuring certain financial and accounting functions and expect
      to
      make several changes to our internal control over financial reporting over
      the
      remainder of fiscal 2008.


23




**PART
      II**–**OTHER INFORMATION**





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





Please
      refer to Part I, Item 3 of our Annual Report on Form 10-K for the fiscal
      year ended December 31, 2007 for a description of material legal proceedings,
      including the proceedings discussed below.





Nouri
      v. Smart Online, Inc. On
      October 17, 2007, Henry Nouri, our former Executive Vice President, filed a
      civil action against us in the General Court of Justice, Superior Court
      Division, in Orange County, North Carolina. The complaint alleged that we had
      no
“cause” to terminate Mr. Nouri’s employment and that we breached Mr. Nouri’s
      employment agreement by notifying him that his employment was terminated for
      cause, by failing to itemize the cause for the termination, and by failing
      to
      pay him benefits to which he would have been entitled had his employment been
      terminated without “cause.” The complaint sought unspecified compensatory
      damages, including interest, a declaratory judgment that no cause existed for
      the termination of Mr. Nouri’s employment and that Mr. Nouri is entitled to the
      benefits provided under his employment agreement for a termination without
      “cause,” and costs and expenses. On December 17, 2007, Mr. Nouri served his
      First Amended Complaint in which he, among other things, added an allegation
      that he was entitled to additional relief because of an alleged “beneficial
      change of ownership” in our company. On January 23, 2008, the parties settled
      this dispute, and on January 24, 2008, the lawsuit was dismissed with
      prejudice.





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





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





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





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





We
      have
      had recurring losses from operations and continue to have negative cash flows.
      If we do not become cash flow positive through additional financing or growth,
      we may have to cease operations and liquidate our business. Our
      working capital, including our line of credit with Paragon, February 2007 equity
      financing transaction, and convertible note financing, should fund our
      operations for the next 12 to 18 months. As of May 12, 2008, we have
      approximately $1 million available on our revolving line of credit and
      approximately $5.2 million available through our convertible note financing.
      Factors such as the commercial success of our existing services and products,
      the timing and success of any new services and products, the progress of our
      research and development efforts, our results of operations, the status of
      competitive services and products, the timing and success of potential strategic
      alliances or potential opportunities to acquire technologies or assets, the
      charges filed against a former officer and a former employee filed by the SEC
      and the United States Attorney General, and the pending shareholder class action
      lawsuit may require us to seek additional funding sooner than we expect. If
      we
      fail to raise sufficient financing, we will not be able to implement our
      business plan and may not be able to sustain our business.


24





**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.





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





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





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


25





In
      addition, we face uncertainty regarding amounts that we may have to pay as
      indemnification to certain current and former officers, directors, and employees
      under our Bylaws and Delaware law with respect to these actions, and we may
      not
      recover all of these amounts from our directors and officers liability insurance
      policy carrier. Our
      Bylaws and Delaware law generally require us to indemnify, and in certain
      circumstances advance legal expenses to, current and former officers and
      directors against claims arising out of such person’s status or activities as
      our officer or director, unless such person (i) did not act in good faith and
      in
      a manner the person reasonably believed to be in or not opposed to our best
      interests or (ii) had reasonable cause to believe his conduct was unlawful.
      As
      of May 12, 2008, there are SEC and criminal actions pending against a former
      executive officer and a former employee who have requested that we indemnify
      them and advance expenses incurred by them in the defense of those actions.
      Also, a stockholder class action lawsuit has been filed against us and certain
      of our current ****** and
      former officers, directors, and employees. The SEC, criminal, and stockholder
      actions are more fully described in Part I, Item 3, “Legal Proceedings,” in our
      Annual Report on Form 10-K for the year ended December 31, 2007.





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





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





In
      addition, our insurance policy provides that, under certain conditions, our
      insurer may have the right to seek recovery of any amounts it paid to the
      individual insureds or us. As of May 12, 2008, we do not know and can offer
      no
      assurances about whether these conditions will apply or whether the insurance
      carrier will change its position regarding coverage related to the current
      actions. Therefore, we can offer no assurances that our insurer will not seek
      to
      recover any amounts paid under its policy from the individual insureds or us.
      If
      such recovery is sought, then we may have to expend considerable financial
      resources in defending and potentially settling or otherwise resolving such
      a
      claim, which could substantially reduce the amount of capital available to
      fund
      our operations.





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





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





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


26





**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
      line
      of credit issued by HSBC, with Atlas as account party. Our secured subordinated
      convertible notes are secured by a first-priority lien on all of our
      unencumbered assets, and a primary subordinated security interest in our
      encumbered assets, as permitted by our agreements with Paragon.





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





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





As
      a
      public company, we have incurred and will continue to incur significant legal,
      accounting, and other expenses that we did not incur as a private company.
      We
      will incur costs associated with our public company reporting requirements.
      We
      also anticipate that we will incur costs associated 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
      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 will be required for the first time for fiscal 2008. 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.





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





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


27





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


28


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





Our
      officers, directors, and principal stockholders beneficially own or control
      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.




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 May 12,
      2008, 18,234,627 shares of our common stock were issued and outstanding and
      a significant number of shares may be issued upon the exercise of outstanding
      options, warrants, and convertible notes.





Our
      stock
      historically has been very thinly traded. The average daily trading volume
      for
      our common stock between January 2008 and April 2008 was approximately 38,468
      shares per day. The number of shares that could be sold during this period
      was
      restrained by previous contractual and other legal limitations imposed on some
      of our shares that are no longer applicable. This means that market supply
      may
      increase more than market demand for our shares. Many companies experience
      a
      decrease in the market price of their shares when such events
      occur.


29





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





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





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





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





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





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





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





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





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





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





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


30





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





On
      January 15, 2008, we issued 28,230 shares of our common stock to a consulting
      firm in full payment of our outstanding obligation in the amount of $228,546
      related to fees accrued for services rendered in conjunction with the 2005
      acquisitions of iMart Incorporated and Computility, Inc. These
      shares were sold in reliance on Rule 506 of Regulation D under the Securities
      Act. The consulting firm is an accredited investor. Neither we nor any person
      acting on our behalf offered or sold the securities by any general solicitation
      or general advertising. A legend was placed on the stock certificate stating
      that the securities have not been registered under the Securities Act and cannot
      be sold or otherwise transferred without an effective registration or exemption
      from registration.





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





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





Exhibit No.
            
            Description3.1
            
            Fifth
                Amended and Restated Bylaws (incorporated herein by reference to
                Exhibit
                3.1 to our Current Report on Form 8-K, as filed with the SEC on March
                25,
                2008)4.1
            
            Commercial
                Note, dated February 20, 2008, payable by Smart Online, Inc. to Paragon
                Commercial Bank10.1
            
            Amendment
                to Employment Agreement, dated February 1, 2008, with Nicholas A.
                Sinigaglia (incorporated herein by reference to Exhibit 10.1 to our
                Current Report on Form 8-K, as filed with the SEC on February 1,
                2008)10.2
            
            Amendment
                to Restricted Stock Award Agreement, dated February 1, 2008, with
                Nicholas
                A. Sinigaglia (incorporated herein by reference to Exhibit 10.2 to
                our
                Current Report on Form 8-K, as filed with the SEC on February 1,
                2008)10.3
            
            Severance
                Agreement and General Release, effective February 18, 2008, with
                Joseph
                Trepanier10.4
            
            Amendment
                to Restricted Stock Agreement, dated February 18, 2008, with Joseph
                F.
                Trepanier10.5
            
            Amendment
                to Reimbursement Agreement, effective February 20, 2008, by and between
                Smart Online, Inc. and Atlas Capital SA10.6
            
            Amendment
                No. 1 to Stock Purchase Warrant and Agreement, effective February
                20,
                2008, by and between Smart Online, Inc. and Atlas Capital SA10.7
            
            Severance
                Agreement and General Release, effective March 31, 2008, with Anil
                Kamath31.1
            
            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.


31


**SIGNATURES**





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





Dated:
      May 12, 2008





**Smart
                Online, Inc.**/s/
                David E. ColburnDavid
                E. ColburnPrincipal
                Executive Officer/s/
                George P. CahillGeorge
                P. CahillPrincipal
                Financial Officer andPrincipal
                Accounting Officer


32


**EXHIBIT
      INDEX**




Exhibit No.
            
            Description3.1
            
            Fifth
                Amended and Restated Bylaws (incorporated herein by reference to
                Exhibit
                3.1 to our Current Report on Form 8-K, as filed with the SEC on March
                25,
                2008)4.1
            
            Commercial
                Note, dated February 20, 2008, payable by Smart Online, Inc. to Paragon
                Commercial Bank10.1
            
            Amendment
                to Employment Agreement, dated February 1, 2008, with Nicholas A.
                Sinigaglia (incorporated herein by reference to Exhibit 10.1 to our
                Current Report on Form 8-K, as filed with the SEC on February 1,
                2008)10.2
            
            Amendment
                to Restricted Stock Award Agreement, dated February 1, 2008, with
                Nicholas
                A. Sinigaglia (incorporated herein by reference to Exhibit 10.2 to
                our
                Current Report on Form 8-K, as filed with the SEC on February 1,
                2008)10.3
            
            Severance
                Agreement and General Release, effective February 18, 2008, with
                Joseph
                Trepanier10.4
            
            Amendment
                to Restricted Stock Agreement, dated February 18, 2008, with Joseph
                F.
                Trepanier10.5
            
            Amendment
                to Reimbursement Agreement, effective February 20, 2008, by and between
                Smart Online, Inc. and Atlas Capital SA10.6
            
            Amendment
                No. 1 to Stock Purchase Warrant and Agreement, effective February
                20,
                2008, by and between Smart Online, Inc. and Atlas Capital SA10.7
            
            Severance
                Agreement and General Release, effective March 31, 2008, with Anil
                Kamath31.1
            
            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.


33