NOTE 10.

CONVERTIBLE DEBT

On July 28, 2011, we completed a second convertible debt financing with Kerry P. Gray, the Company's Chairman, President, and Chief Executive Officer (the “July 2011 Debt Offering”). The convertible note for $125,000 will bear interest at the rate of 10.0% per annum, with annual payments of interest commencing on July 1, 2012. The full amount of principal and any unpaid interest will be due on July 28, 2014. The outstanding principal balance of the note may be converted into shares of the Company's common stock, at the option of the note holder and at any time, at a conversion price of $1.08 per share or 115,741 shares of common stock. The Company may force conversion of the convertible note if our common stock trades for a defined period of time at a price greater than $2.16. The convertible note is secured by the grant of a security interest in the inventory, accounts receivables and capital equipment held by the Company. As part of the convertible debt financing, Mr. Gray also received a warrant to purchase up to 34,722 shares of the Company's common stock. The warrant has an exercise price of $1.08 per share and is exercisable at any time until July 28, 2016. The securities issuable on conversion have not been registered under the Securities Act of 1933 and may not be sold absent registration or an applicable exemption from the registration requirements.

The Company accounts for convertible debt using specific guidelines in accordance with U.S. GAAP. The Company allocated the value of the proceeds received to the convertible instrument and to the warrant on a relative fair value basis. The Company calculated the fair value of the warrant issued with the convertible instrument using the Black-Scholes valuation method, using the same assumptions used for valuing employee stock options, except the contractual life of the warrant was used. Using the effective interest method, the allocated fair value was recorded as a debt discount and is being amortized over the expected term of the convertible debt to interest expense.

On the date of issuance of the July 2011 convertible note, no portion of the proceeds was attributable to a beneficial conversion feature since the conversion price of the July 2011 convertible note exceeded the market price of the Company's common stock.

Information relating to our convertible notes payable is as follows:

									As of September 30, 2011
Transaction	Initial Principal Amount		Interest Rate			Maturity Date	Fixed Conversion Price		Principal Balance		Unamortized Debt Discount		Carrying Value
June 2011 Note	$	140,000		10.0	%	06/13/2014	$	1.20	$	140,000	$	11,363	$	128,637

July 2011 Note		125,000		10.0	%	07/28/2014	$	1.08		125,000		21,947		103,053

Total	$	265,000							$	265,000	$	33,310	$	231,690

The amount of interest cost recognized from the two convertible notes outstanding was $5,724 and nil for the three months ended September 30, 2011 and 2010, respectively and was $6,376 and nil for the nine months ended September 30, 2011 and 2010, respectively.