This was posted about two years ago (by JB )on this forum and is still the solution.....pay attention to 6 & 7.
"1. open up SMTP properties in IIS,
2. select the access tab,
3. click on connection (4th button from the top)
4. grant access to all expect the list below, make sure the checkbox to allow all is checked
5. click on ok,
6. click on relay (5th button from the top)
7. grant access to all except the list below,
make sure the checkbox to allow all is checked
8. click on apply, click on ok, and run a mail() test using localhost as your smtp server.
9. this time it should work.. 🙂
"