Note 5: CONVERTIBLE NOTES PAYABLE

The following is a summary of debt instrument transactions that are relevant to the current period:

	Face Value		Principal Repayment		Unamortized Note Discount		Balance at December 31, 2011

February 2011 Secured Convertible Notes
Senior Secured Notes, due February 24, 2014	$	1,184,694	$	-	$	346,640	$	838,054

April 2011 Secured Convertible Notes
Senior Secured Notes, due April 4, 2014		215,000		-		77,539		137,461

June 2011 Secured Convertible Note
Senior Secured Notes, due June 6, 2014		30,000		-		6,725		23,275
Total	$	1,429,694	$	-	$	430,904	$	998,790

February 2011 Secured Convertible Notes

On February 24, 2011, the Company entered into a securities purchase agreement with accredited investors to place Senior Secured Convertible Notes (the “February 2011 Notes”) with a maturity date of three years after the issuance thereof in the aggregate principal amount of $1,184,694. Consideration under the notes consisted of $944,694 in cash proceeds, including accrued interest, and $240,000 was subscribed for by two of the holders of outstanding and demandable 2010 secured convertible notes (the “2010 Notes”). The holders of the 2010 Notes returned their Series A, Series B and Series C warrants to the Company for cancellation. In connection with the issuance of the February 2011 Notes, the Company entered into a 2011 Security Agreement with the note holders securing the February 2011 Notes with all of the Company’s assets. One year after the issuance of the February 2011 Notes, the note holders have the option to convert a portion or all of the outstanding balance of the February 2011 Notes including any accrued interest into shares of the Company’s common stock at a conversion rate of $0.15 per share.

The February 2011 Notes bear interest at the rate of 10% per annum except in case of default, in which case they bear interest at the rate of 20% per annum. The interest is due on the February 2011 Notes at the end of each three month period, starting three months from their issuance. One year after the issuance of the February 2011 Notes, the Company may elect to prepay a portion of the principal. If the Company makes such an election, the holders may elect to receive such prepayment in cash or in shares of the Company’s common stock, at a conversion rate of $0.15 per share, or in a combination thereof.

The Company paid a finders’ fee of $41,500. The finder’s fee was accounted for as deferred financing costs, and is being amortized over the term of the notes. At December 31, 2011, $28,879 of the $32,291 in deferred financing costs relates to the February 2011 Notes which remains unamortized, and is presented in long-term assets on the Company’s Balance Sheet.

In connection with the issuance of the February 2011 Notes, the Company issued 2,369,388 warrants, exercisable into common stock at $0.25 with five year terms. The Company may force the exercise of the warrants at any time that the average volume weighted average price of the Company’s common stock over the prior ten trading days is greater than $0.50, the average daily dollar volume of the Company’s common stock sold over those ten trading days is greater than $25,000 and there is an effective registration statement covering the resale of the shares underlying the warrants.

After reviewing the Fundamental Transaction clause contained in the warrants, the Company revised its interim accounting for the 2011 Notes. The Company has allocated the net proceeds to the warrants based on the calculated fair value at the date of issuance. The fair value of the warrants was recorded at $483,355 and recognized as derivative liabilities and the debt was recorded at $701,339. The fair value of the warrants was calculated using the Binomial option pricing model under the following assumptions: estimated life of five years, risk free rate of 2.06%, dividend yield of 0% and volatility of 199%. The debt discount is being accreted over the three year term of the February 2011 Notes using the effective interest rate method.

For the year ended December 31, 2011, accretion of the debt discount of $136,715 was recorded for the February 2011 Notes.

April 2011 Secured Convertible Notes

On April 4, 2011, the Company entered into a securities purchase agreement with accredited investors to place Senior Secured Convertible Notes (the “April 2011 Notes”) with a maturity date of three years after the issuance thereof in the aggregate principal amount of $215,000. Consideration under the notes consisted of $190,000 in cash proceeds, and $25,000 was subscribed for by a holder of 2010 Notes in exchange for the extinguishment of the Series A, Series B and Series C warrants related to the 2010 Notes. In connection with the issuance of the April 2011 Notes, the Company entered into a 2011 Security Agreement with the note holders securing the April 2011 Notes with a secondary security interest in all of the Company’s assets. One year after the issuance of the April 2011 Notes, the note holders have the option to convert a portion or all of the outstanding balance of the April 2011 Notes including any accrued interest into shares of the Company’s common stock at a conversion rate of $0.15 per share.

The April 2011 Notes bear interest at the rate of 10% per annum except in case of default, in which case they bear interest at the rate of 20% per annum. The interest is due on the April 2011 Notes at the end of each three month period, starting three months from their issuance. One year after the issuance of the April 2011 Notes, the Company may elect to prepay a portion of the principal. If the Company makes such an election, the holders may elect to receive such prepayment in cash or in shares of the Company’s common stock, at a conversion rate of $0.15 per share, or in a combination thereof.

The Company paid a finders’ fee of $4,550. The finder’s fee was accounted for as deferred financing costs, and is being amortized over the term of the notes. At December 31, 2011, $3,412 of the $32,291 in deferred financing costs relates to the April 2011 Notes which remains unamortized, and is presented in long-term assets on the Company’s Balance Sheet.

In connection with the issuance of the April 2011 Notes, the Company issued 430,000 warrants, exercisable into common stock at $0.25 with 2 year terms. The Company may force the exercise of the warrants at any time that the average volume weighted average price of the Company’s common stock over the prior ten trading days is greater than $0.50, the average daily dollar volume of the Company’s common stock sold over those ten trading days is greater than $25,000 and there is an effective registration statement covering the resale of the shares underlying the warrants.

The Company has allocated the net proceeds to the warrants based on the calculated fair value. The fair value of the warrants was recorded at $130,720 and recognized as derivative liabilities and the debt was recorded at $84,280. The fair value of the warrants was calculated using the Binomial option pricing model under the following assumptions: estimated life of two years, risk free rate of 0.77%, dividend yield of 0% and volatility of 199%. The debt discount is being accreted over the three year term of the April 2011 Notes using the effective interest rate method.

For the year ended December 31, 2011, accretion of the debt discount of $53,162 was recorded for the April 2011 Notes.

June 2011 Secured Convertible Note

On June 6, 2011, the Company entered into a securities purchase agreement with accredited investors to place Senior Secured Convertible Note (the “June 2011 Note”) with a maturity date of three years after the issuance thereof in the aggregate principal amount of $30,000. In connection with the issuance of the June 2011 Note, the Company entered into a 2011 Security Agreement with the note holder securing the June 2011 Note with a secondary security interest in all of the Company’s assets. One year after the issuance of the June 2011 Note, the note holder has the option to convert a portion or all of the outstanding balance of the June 2011 Note including any accrued interest into shares of the Company’s common stock at a conversion rate of $0.15 per share.

The June 2011 Note bears interest at the rate of 10% per annum except in case of default, in which case it bears interest at the rate of 20% per annum. The interest is due on the June 2011 Note at the end of each three month period, starting three months from its issuance. One year after the issuance of the June 2011 Note, the Company may elect to prepay a portion of the principal. If the Company makes such an election, the holders may elect to receive such prepayment in cash or in shares of the Company’s common stock, at a conversion rate of $0.15 per share, or in a combination thereof.

In connection with the issuance of the June 2011 Note, the Company issued 60,000 warrants, exercisable into common stock at $0.25 with two year terms. The Company may force the exercise of the warrants at any time that the average volume weighted average price of the Company’s common stock over the prior ten trading days is greater than $0.50, the average daily dollar volume of the Company’s common stock sold over those ten trading days is greater than $25,000 and there is an effective registration statement covering the resale of the shares underlying the warrants.

The Company has allocated the net proceeds to the warrants based on the calculated fair value. The fair value of the warrants was recorded at $8,280 and recognized as derivative liabilities and the debt was recorded at $21,720. The fair value of the warrants was calculated using the Binomial option pricing model under the following assumptions: estimated life of two years, risk free rate of 0.43%, dividend yield of 0% and volatility of 199%. The debt discount is being accreted over the three year term of the June 2011 Note using the effective interest rate method.

For the year ended December 31, 2011, accretion of the debt discount of $1,575 was recorded for the June 2011 Note.

The following is a summary of debt instrument transactions that are relevant to the current and prior period:

May 2010 Secured Convertible Notes

	Face Value		Principal Repayment in Cash			Principal Repayment in Shares and Warrants			Principal Repayment in February 2011 Notes			Balance at December 31, 2011

May 2010 Secured Convertible Notes
Senior Secured Notes, due May 19, 2011	$	1,530,000	$	(1,053,333	)	$	(316,667	)	$	(160,000	)	$	-

	Face Value		Principal Repayment			Unamortized Note Discount			Balance at December 31, 2010

2010 Secured Convertible Notes
Senior Secured Notes, due May 19, 2011	$	1,530,000	$	(573,333	)	$	(603,617	)	$	353,050

On May 24, 2010, the Company entered into a securities purchase agreement with accredited investors to place the 2010 Notes with a maturity date of one year after the issuance thereof in the aggregate principal amount of $1,530,000 for gross consideration of $1,275,000. The $1,275,000 consisted of $712,254 in cash proceeds to the Company, $212,746 of services and $350,000 was subscribed for by the holder of a matured 2009 convertible debenture. In connection with the issuance of the notes, the Company entered into a 2010 Security Agreement with the note holders securing the 2010 Notes with all of the Company’s assets. The 2010 Note holders had the option to convert the outstanding balance of the notes including any accrued interest into shares of the Company’s common stock at a maximum conversion rate of $0.30 per share at any time.

The 2010 Notes were placed at a 20% discount from their face value and bore no interest except in case of an event of default, in which case they would bear interest at the rate of 18% per annum. The principal and any interest due on the 2010 Notes was due in 9 equal monthly installments starting in September 2010. Subject to the satisfaction of certain customary conditions including the effectiveness of a registration statement and certain minimums on the amount and value of the shares of the Company’s common stock traded on the Over-the-Counter Bulletin Board, the Company could elect to pay amounts due on any installment date in either cash or shares of its common stock. Any shares of its common stock that the Company issued as payment on an installment date would have been issued at a price which would be equal to the lesser of $0.30 per share or 85% of the average of the volume-weighted average prices of the Company’s common stock on the Over-the-Counter Bulletin Board on each of the twenty trading days immediately preceding the applicable installment date.

The Company paid a finders’ fee of $64,000 and issued 1,400,000 broker’s warrants (described below) valued at $167,000. The finder’s fee and fair value of the broker’s warrants was accounted for as deferred financing costs, and was being amortized over the term of the notes. During the year ended December 31, 2011, $66,267 of the deferred financing costs were amortized and the remaining balance of $38,626 was recognized as loss on settlement of debt.

In February 2011, the Company negotiated an early settlement of $640,000 of the outstanding 2010 Notes and the cancellation of 4,000,000 Series A Warrants, 3,200,000 Series B Warrants and 4,000,000 Series C Warrants. Pursuant to the settlement agreement, the Company paid $480,000 in cash, issued $240,000 in February 2011 Notes. Under the agreement, those holders released the Company from the remaining obligations under the securities purchase agreement entered into during fiscal year 2010, the 2010 security agreement and other conditions related to the issuance of the 2010 Notes.

In March 2011, the Company entered into a debt settlement and warrant extinguishment agreement to settle $83,333 of the 2010 Notes and retire 625,000 Series A Warrants, 500,000 Series B Warrants and 625,000 Series C Warrants of the Company by issuing to the 2010 Note holder 641,023 shares of common stock and a new warrant to purchase up to 250,000 shares of common stock (Note 9).

In addition, the Company has also entered into an agreement to settle the remaining $233,333 of the 2010 Notes in exchange for 2,048,578 common shares (Note 9). Further, the Company entered into an agreement with a former 2010 Note holder to extinguish the 4,900,000 warrants related to the 2010 Note to extinguish those warrants for a new warrant to purchase 1,000,000 shares of common stock and a new April 2011 Note for $25,000.

During the year ended December 31, 2011, the Company settled all of the outstanding 2010 Notes. The settlement of the 2010 Notes, was completed by cash payments, share and warrant issuances and the issuance of February 2011 Notes. In aggregate the fair value of the consideration was $1,194,844, which resulted in a gain on debt settlement of $307,136. In addition, the negotiated early extinguishment of the Series A, B and C warrants resulted in a gain of $290,500.