Exhibit 10.1

(VAUGHAN FOODS LOGO)

July 26, 2010

Moore, Oklahoma

THIS NOTE HAS NOT BEEN REGISTERED OR QUALIFIED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, OR ANY STATE SECURITIES LAW (COLLECTIVELY, THE “SECURITIES LAWS”), AND HAS BEEN ACQUIRED FOR INVESTMENT AND NOT WITH A VIEW TO, OR IN CONNECTION WITH, THE SALE OR DISTRIBUTION THEREOF. THIS NOTE MAY NOT BE SOLD, OFFERED FOR SALE OR OTHERWISE TRANSFERRED UNLESS IT (I) IS REGISTERED OR QUALIFIED UNDER ALL APPLICABLE SECURITIES LAWS OR (II) IS EXEMPT FROM REGISTRATION OR QUALIFICATION UNDER SUCH LAWS AND THE ISSUER IS PROVIDED WITH AN OPINION OF COUNSEL SATISFACTORY TO THE ISSUER THAT SUCH REGISTRATION OR QUALIFICATION IS NOT REQUIRED.

PROMISSORY NOTE

FOR VALUE RECEIVED, Vaughan Foods, Inc., an Oklahoma corporation (“Debtor”), promises to pay to Herbert B. Grimes (“Lender”), at the offices of the Debtor, on the dates listed in Schedule A (the “Maturity Dates”) the principal sum of EIGHT HUNDRED EIGHTY THOUSAND, NINE HUNDRED NINE DOLLARS ($880,909.00), together with interest thereon at the rate of ten percent (10%) per annum, compounded daily. Lender may, at his option, elect to defer some or all of any scheduled payments listed in Schedule A. This Promissory Note replaces that certain Promissory Note dated June 30, 2009 in the amount $882,750.00, and is given in satisfaction of the remaining balance on that Promissory Note dated, June 30, 2010. This Promissory Note is executed on the date noted above and is effective as of June 30, 2010.

Lender understands and agrees that the scheduled payments listed Schedule A include negative amortization provisions, such that some payments are not sufficient to satisfy all accrued interest through the dates of the payments, and that such insufficiencies shall be added to the principal balances, as necessary.

If this Note, or any payment hereunder, falls due on a Saturday, Sunday or a day that is a public holiday in the State of Oklahoma, this Note shall become due or such payment hereunder, shall be made on the next succeeding business day and such additional time shall be included in the computation of any interest payable hereunder.

Debtor may at its option prepay all or any part of the unpaid principal amount of this Note and accrued interest thereon, without premium or penalty. Any partial prepayment shall be applied first to interest

and the remaining balance of such payment, if any, to principal. If any provision of this Note would require Debtor to pay interest hereon at a rate exceeding the highest rate allowed by applicable law, Debtor shall instead pay interest under this Note at the highest rate permitted by applicable law.

Further agreed that the Lender and Debtor will review the review the prospects, liquidity position, projected cash flows and EBITDA position of the Debtor by September 1, 2010, for the purpose of evaluating the Debtor’s ability to meet the payments referred to in Schedule A without undue burden on the ability of the Debtor to continue as a going concern. If it is mutually determined that the Debtor is unable to meet the payment plan referred to in Schedule A, then the Lender and Debtor hereby agree to mutually determine an alternative payment plan.

“EBITDA” means (a) Net Income, plus (b) Interest Expense, plus (c) to the extent deducted in the calculation of Net Income, depreciation expense and amortization expense, plus (d) income tax expense, if any. Income tax benefit shall not be considered in the determination of EBITDA.

This Note and the indebtedness evidenced thereby is and shall be junior and subordinate in all respects to the payment of all indebtedness of the Debtor for borrowed money, including without limitation, indebtedness evidenced by that certain Loan And Security Agreement entered into as of March 6, 2009, by and between Peninsula Bank Business Funding, a division of The Private Bank of the Peninsula (“Bank”) and Vaughan Foods, Inc. and Wild About Food – Oklahoma LLC., and related loan agreements, as the same may be renewed, amended or extended after the date hereof.

Lender has represented that he has treated the sale of Allison’s on the installment method of accounting for income tax purposes. Under the installment method, Lender would be taxed when he receives the principal payment s for the sale. At the time of the sale in 2007, the long term capital gains tax rate was 15%. However, if capital gains tax rates are adjusted such that , Lender would be assessed a higher tax due solely to the deferral, then Debtor agrees to “gross up” to Lender to make him whole for the additional potential taxes.

The following is an example of a gross up scenario, assuming a capital gains rate of 20% and a combined marginal income tax rate and Medicare tax rate of 50% - this table is shown as an example only, and does not necessarily represent the actual gross up that would be paid to Lender, but merely serves to illustrate the methodology under which a gross up would be paid.

Prior to any gross up being paid by Debtor, Lender agrees to engage a Certified Public Accountant that is competent in federal tax law and who understands Lender’s tax situation that will provide written representation to Debtor that the proposed gross up is materially correct, and generally serves to make Lender whole as a result of any adjustments to the federal capital gains tax rates.


Herb Grimes Pro Forma Tax Gross Up Example for Allison’s Transaction

Tax gain on sale of Allison’s interest that has been deferred	$	802,500
Long term capital gains rate at transaction time - 2007		15	%
Pro forma tax - as if tax was paid at the time of the transaction - tax year 2007		120,375
Pro forma (adjusted) capital gains rate at payment time		20	%
Pro forma tax that would be paid under adjusted tax rate		160,500
Difference in tax		40,125

Additional net amount to be paid to Grimes to pay the difference in taxes		40,125
Assumed combined income tax and medicare tax rate at time of payment		50	%

Amount to be paid to Mr. Grimes to get net amount required to pay additional taxes	$	80,250


Proof
Gross amount to be paid to Grimes	$	80,250
Tax on gross amount		(40,125	)

Net amount to Mr. Grimes to pay additional capital gains taxes	$	40,125

IN WITNESS WHEREOF, Debtor has executed this Promissory Note as of the date first above written.

Vaughan Foods, Inc. (“Debtor”)


/s/ Gene P. Jones

By: Gene P. Jones
Secretary, Treasurer and Chief Financial Officer


		Schedule A

	Payment Date	Payment Amount	Interest Applied	Principal Applied	Principal Balance

Loan	06/30/2010				880,909.00

1	07/07/2010	1,500.00	1,694.06	194.06-	881,103.06

2	07/14/2010	1,500.00	1,694.43	194.43-	881,297.49

3	07/21/2010	1,500.00	1,694.80	194.80-	881,492.29

4	07/28/2010	1,500.00	1,695.18	195.18-	881,687.47

5	08/04/2010	1,500.00	1,695.55	195.55-	881,883.02

6	08/11/2010	1,500.00	1,695.93	195.93-	882,078.95

7	08/18/2010	1,500.00	1,696.31	196.31-	882,275.26

8	08/25/2010	1,500.00	1,696.68	196.68-	882,471.94

9	09/01/2010	1,500.00	1,697.06	197.06-	882,669.00

10	09/08/2010	1,500.00	1,697.44	197.44-	882,866.44

11	09/15/2010	1,500.00	1,697.82	197.82-	883,064.26

12	09/22/2010	1,500.00	1,698.20	198.20-	883,262.46

13	09/29/2010	884,961.04	1,698.58	883,262.46	0.00


(Mark One)

þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

OR

o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to

Commission file number 001-33446

VAUGHAN FOODS, INC.

(Exact name of registrant as specified in its charter)


Oklahoma		73-1342046
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

216 N.E. 12th Street, Moore, OK		73160
(Address of principal executive offices)		(Zip Code)

(405) 794-2530
(Registrant’s telephone number, including area code)


Large accelerated filer o	Accelerated filer o	Non-accelerated filer o	Smaller reporting company þ


Number of shares outstanding of the registrant’s common stock, as of August 16, 2010:
Class		Shares Outstanding


Common Stock, $0.001 par value per share		9,380,577


PART I – FINANCIAL INFORMATION

	Item 1.	Financial Statements	1

		Consolidated Balance Sheets as of June 30, 2010 (unaudited), and December 31, 2009	2

		Unaudited Consolidated Statements of Operations for the Three Months and Six Months Ended June 30, 2010 and 2009	3

		Consolidated Statements of Stockholders’ Equity for the Year Ended December 31, 2009 and Six Months Ended June 30, 2010 (unaudited)	4

		Unaudited Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009	5

		Notes to Unaudited Consolidated Financial Statements	6

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	20

	Item 4.	Controls and Procedures	20

PART II — OTHER INFORMATION

	Item 1.	Legal Proceedings	21

	Item 1A.	Risk Factors	21

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	21

	Item 3.	Defaults Upon Senior Secruties	21

	Item 4.	[Removed and Reserved]	21

	Item 5.	Other Information	21

	Item 6.	Exhibits	22

SIGNATURES			23

EXHIBIT INDEX


	June 30, 2010			December 31, 2009

	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	-		$	-
Cash receipts subject to account control agreement		971,052			523,454
Accounts receivable, net of allowance for credit losses of $56,375 at June 30, 2010 and $106,375 at December 31, 2009		6,695,670			5,311,989
Inventories		2,816,606			3,054,819
Prepaid expenses and other assets		249,506			210,516
Deferred tax assets		270,924			264,772


Total current assets		11,003,758			9,365,550


Restricted assets:
Cash		528,000			528,000
Investments		757,564			541,398


Total restricted assets		1,285,564			1,069,398


Property and equipment, net		15,318,112			15,797,007


Other assets:
Loan origination fees, net of amortization		330,722			421,791
Intangible assets		61,666			77,090
Deferred tax assets, noncurrent		2,368,748			2,655,925


Total other assets		2,761,136			3,154,806


Total assets	$	30,368,570		$	29,386,761



Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	8,397,354		$	8,431,570
Disbursements in transit		749,178			1,269,790
Line of credit		1,871,607			2,322,063
Note payable to former owners of Allisons Gourmet Kitchens, LP		880,909			875,617
Accrued liabilities		1,662,315			1,392,817
Current portion of long-term debt		1,482,231			1,138,602
Current portion of capital lease obligation		11,779			94,479


Total current liabilities		15,055,373			15,524,938


Long term liabilities:
Long-term debt, net of current portion		6,285,323			6,943,639
Deferred gain on sale of assets		25,677			43,607


Total long-term liabilities		6,311,000			6,987,246


Stockholders’ equity:
Common stock, $0.001 par value; authorized 50,000,000 shares; 9,380,577 shares issued and outstanding at June 30, 2010 and 4,623,077 shares issued and outstanding at December 31, 2009		9,381			4,623
Preferred stock, $0.001 par value; authorized 5,000,000 shares; 0 shares issued and outstanding at June 30, 2010 and December 31, 2009		-			-
Paid in Capital		14,480,212			12,734,115
Retained Earnings (deficit)		(5,487,396	)		(5,864,161	)


Total stockholders’ equity		9,002,197			6,874,577


Total liabilities and stockholders’ equity	$	30,368,570		$	29,386,761


	Three Months Ended June 30,						Six Months Ended June 30,

	2010			2009			2010			2009

	(unaudited)			(unaudited)			(unaudited)			(unaudited)
Net sales	$	26,225,764		$	27,465,917		$	47,921,629		$	49,784,922
Cost of sales		23,476,533			24,825,433			42,410,244			45,188,883


Gross profit		2,749,231			2,640,484			5,511,385			4,596,039

Selling, general and administrative expenses		2,127,186			2,328,778			4,397,614			4,483,260


Operating income (loss)		622,045			311,706			1,113,771			112,779

Interest expense		(207,488	)		(289,350	)		(476,670	)		(515,880	)
Gain (loss) on sale of asset		11,724			9,868			20,689			6,079
Interest income		-			4			-			110


Other income and expense, net		(195,764	)		(279,478	)		(455,981	)		(509,691	)


Net income (loss) before income taxes		426,281			32,228			657,790			(396,912	)

Income tax expense (benefit)		166,107			14,684			281,025			(148,513	)


Net income (loss)	$	260,174		$	17,544		$	376,765		$	(248,399	)


Weighted average shares outstanding
Basic		9,380,577			4,623,077			7,961,212			4,623,077
Diluted		9,384,660			4,759,932			7,962,165			4,623,077

Net income (loss) per share
Basic	$	0.03		$	0.00		$	0.05		$	(0.05	)
Diluted	$	0.03		$	0.00		$	0.05		$	(0.05	)


	Common Stock				Paid in Capital		Retained Earnings (Deficit)			Total Stockholders’ Equity

	Shares issued		Amount


Balance at January 1, 2009		4,623,077	$	4,623	$	12,571,302	$	(5,363,934	)	$	7,211,991

Issuance of stock options in connection with Equity Incentive Plan		-		-		88,352		-			88,352
Issuance of stock warrants in connection with refinancing revolving line of credit						74,461					74,461
Net (loss)		-		-		-		(500,227	)		(500,227	)


Balance at December 31, 2009		4,623,077	$	4,623	$	12,734,115	$	(5,864,161	)	$	6,874,577

Stock-based compensation expense (unaudited)		-		-		44,967		-			44,967
Issuance of common stock in connection with private placement transaction (unaudited)		4,757,500		4,758		1,701,130		-			1,705,888
Net income (unaudited)		-		-		-		376,765			376,765


Balance at June 30, 2010 (unaudited)		9,380,577	$	9,381	$	14,480,212	$	(5,487,396	)	$	9,002,197


(1)	Nature of Operations

Vaughan Foods, Inc. (the “Company”) is an Oklahoma-based specialty food processor serving customers in a multi-state region. The Company and its subsidiaries operate from processing facilities in Moore, Oklahoma and Fort Worth, Texas.

(2)	Summary of Significant Accounting Policies

	(a)	Basis of Reporting

		The accompanying consolidated financial statements and notes thereto have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, certain disclosures normally prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. The accompanying consolidated financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report filed on Form 10-K with the SEC on March 19, 2010.

		This summary of significant accounting policies is presented to assist in understanding the Company’s consolidated financial statements. The consolidated financial statements and notes are representations of the Company’s management which is responsible for the integrity and objectivity of the consolidated financial statements. These accounting policies conform to accounting principles generally accepted in the United States of America and have been consistently applied in the preparation of the consolidated financial statements.

	(b)	Unaudited Interim Financial Information

		The financial information herein is unaudited; however, such information reflects solely normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. Operating results of the interim period are not necessarily indicative of the amounts that will be reported for the entire year.

	(c)	Cash and Cash Equivalents

		For purposes of the consolidated statements of cash flows, the Company considers investments with maturities of three months or less at date of purchase to be cash equivalents. Cash subject to account control agreement represent unrestricted cash that results from collections of trade accounts receivable. Such amounts are generally applied the next business day to outstanding balances and accrued interest on the revolving credit agreement, and subject to availability and other terms of the agreement, can be re-borrowed immediately after being applied to the line of credit.

	(d)	Disbursements in Transit

		Disbursements in transit as presented in the consolidated balance sheet and consolidated statement of cash flows, represent drafts for payment to the Company’s vendors in transit and in the process of being collected.

	(e)	Accounts Receivable and Credit Policies

		Trade accounts receivable are customer obligations due under normal trade terms generally requiring payment within 15 to 21 days from the invoice date. Receivables are recorded based on the amounts invoiced to customers. Interest and delinquency fees are not included in income until realized in cash. Discounts allowed for early payment, if any, are charged against income when the payment is received. Payments of accounts receivable are allocated to the specific invoices identified on the customer’s remittance advice or, if unspecified, are generally applied to the earliest unpaid invoices.

		The carrying amount of accounts receivable is reduced by an allowance for credit losses that reflects management’s estimate of the amounts that will not be collected. The allowance for credit losses is based on various factors including among other things, (a) our assessment of the collectibility of specific customer accounts, (b) our macro assessment of political and economic risk, (c) the overall aging of accounts receivable portfolio, and (d) the effects each of these and other factors have on the consolidated portfolio. Balances still outstanding after management has used reasonable collection efforts are charged off to the valuation allowance. Recoveries on accounts previously charged off are credited to the valuation allowance.

		A lien exists on certain receivables related to fresh produce under the Perishable Agricultural Commodities Act of 1930, which partially subordinates the lien placed by the line of credit.


	(f)	Inventories

		Inventories consist principally of food products and are stated at the lower of average cost (which approximates first-in, first-out) or market. Costs included in inventories consist of materials, certain prepaid expenses related to materials, packaging supplies, and labor. General and administrative costs are not charged to inventories.

	(g)	Property and Equipment

		Property and equipment are recorded at cost. Equipment classified as capital leases are recorded at the present value of the future minimum lease payments, and amortized on a straight-line basis over the shorter of the lease term or the estimated useful life of the asset. Expenditures for major additions and improvements are capitalized, while minor replacements, maintenance and repairs are charged to expense as incurred. When property and equipment are retired or otherwise disposed of, the cost of the asset and related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in other income and expense.

		Depreciation, including assets classified as capital leases, are provided using the straight-line method over the following estimated useful lives:


Plant and improvements		15 - 40 years

Machinery and equipment		2 - 15 years

Transportation equipment		3 - 10 years

Office equipment		2 - 7 years


	(h)	Concentrations of Credit Risk

		The Company maintains its cash in bank deposit accounts which, at times, may exceed federally insured limits. The Company has not experienced any losses in such accounts. The Company believes it is not exposed to any significant credit risk on cash and cash equivalents.

	(i)	Revenue Recognition

		The Company recognizes revenue, net of related sales discounts and allowances, when persuasive evidence of an arrangement exists (such as a customer purchase order), delivery has occurred, the price to the customer has been fixed or is determinable, and collectibility is reasonably assured. Revenues also include those amounts related to shipping and handling. Shipping and handling expenses are included in cost of sales. Consideration from the Company to a customer is presumed to be a reduction to the selling price of the Company’s products and accordingly, is characterized as a reduction of sales when recognized in the Company’s consolidated statements of operations. As a result, certain promotional expenses are recorded as a reduction of net sales, at the time in which the sale is recognized.

	(j)	Accounting for Rebates

		The Company establishes liabilities for rebates to customers based on specific programs, expected usage and historical experience.

	(k)	Income Taxes

		Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

	(l)	Earnings (Loss) Per Share

		Basic earnings (loss) per share (“EPS”) excludes dilution and is calculated by dividing net income (loss) available to common stockholders by the weighted-average number of shares of common stock outstanding during the period. Diluted EPS is computed in a manner similar to that of basic EPS except that the weighted-average number of common shares outstanding is increased to include the number of incremental common shares (computed using the treasury stock method) that would have been outstanding if all potentially dilutive common shares (such as stock options) were issued during the period. Diluted EPS is not presented if the effect of the incremental shares is anti-dilutive.


	As of June 30, 2010, the Company has Class A and Class B warrants outstanding resulting from its initial public offering with exercise prices of $9.75 and $13.00, respectively. Both classes of warrants expire on June 27, 2012. The exercise price of both classes of warrants exceeds the Company’s stock price, therefore the Company has not included these warrants as shares in diluted earnings per share because the effects of inclusion would be anti-dilutive.

	On November 26, 2008 and March 12, 2009, the Company granted 605,000 and 14,120, respectively, stock options to certain employees, members of the board of directors and certain consultants to the Company, vesting over four years, with a weighted average exercise price of $0.70. The exercise price of the options is equal to the Company’s stock price on the date of issuance, which exceeds the Company’s average stock price, therefore the Company has not included these options as shares in diluted earnings per share because the effects of inclusion would be anti-dilutive.

	On March 6, 2009, the Company issued a seven year warrant to purchase 252,454 shares of common stock to its lender in connection with refinancing its revolving line of credit, as further described in Note 7. The exercise price of the warrant $0.59 per share, which is less than the Company’s average stock price, therefore the Company has included these options associated with the warrant in diluted earnings per share.

	On February 24, 2010, the Company issued five year warrants to purchase 1,903,000 shares of common stock to 71 accredited investors in connection with a private placement transaction. The exercise price of the warrants is $0.70 per share, which is greater than the Company’s average stock price, therefore the Company has not included these options associated with the warrants in diluted earnings per share because the effects of inclusion would be anti-dilutive.

	On February 23, 2010, the Company issued five year warrants to purchase 475,750 shares of common stock to the placement agent in connection with a private placement transaction. The exercise price of the warrants is $0.625 per share, which is greater than the Company’s average stock price, therefore the Company has not included these options associated with the warrants in diluted earnings per share because the effects of inclusion would be anti-dilutive.

(m)	Use of Estimates

	The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

(n)	Fair Value of Financial Instruments

	The carrying value of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities are measured at cost which approximates fair value because of the short-term nature of these instruments. The carrying amount of the Company’s borrowings under the line of credit and long-term debt approximates fair value because the interest rate on the instruments fluctuate with market interest rates or represents borrowing rates available with similar terms.

(o)	Investments

	All of the Company’s investments are classified as available for sale and are stated at fair value. Any related unrealized gains and losses are excluded from earnings and reported net of income tax as a separate component of stockholders’ equity until realized. There were no unrealized gains or losses for the three months or six months ended June 30, 2010 and 2009. Realized gains and losses on sales of securities are based on the specific identification method. Declines in the fair value of investment securities below their carrying value that are other than temporary are recognized in earnings. As of June 30, 2010 and December 31, 2009, the Company’s investments consisted primarily of guaranteed investment contracts at a fixed interest rate of 2.25 percent.

(p)	Stock-Based Compensation Expense

	The Company measures stock-based compensation costs at the grant date based on the fair value of the award and recognize as expense ratably over the service period, net of estimated forfeitures. The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock option awards. The Company awards stock options to employees, executive officers, directors and certain consultants.


	(q)	Recently Issued Accounting Pronouncements

		In June 2009, the FASB issued Accounting Standards Codification ASC 105-10, which establishes the Codification as the single source of authoritative nongovernmental U.S. generally accepted accounting principles (“GAAP”). The Codification, which changes the referencing of the financial accounting standards, became effective and was adopted by the Company for interim and annual periods ending after September 15, 2009. All existing accounting standards are superseded by the Codification, which is now the single official source of authoritative U.S. GAAP. All other accounting literature not included in the Codification is non-authoritative. Updates to the ASC are issued in the form of Accounting Standards Updates (“ASU”). The Codification does not change U.S. GAAP, and its adoption did not have a material effect on the Company’s financial statements.

(3)	Operating Results and Liquidity

		The Company incurred a loss of $3.4 million in 2008, used cash of $2.7 million and experienced a decrease in working capital of $6.6 million. In 2009, the Company incurred a net loss of $0.5 million, and experienced a further decrease in working capital. During 2008 and 2009, management took several actions to provide assurance that the Company would continue as a going concern, including plans to enhance and conserve liquidity and capital resources. These plans included, among other things, (a) aggressive cost and cash management, including a moratorium on hiring of non-core personnel, compensation adjustments, and non-essential capital expenditures, (b) increased operational discipline, including the completion of the implementation of an Enterprise Resource Planning system designed to strengthen internal accounting and operational controls, and provide considerably more transparency and visibility into the business, (c) timely and adequate pricing adjustments to mitigate changes in input costs, (d) undertaking steps to mitigate the effects of changes in certain input and commodity costs, (e) continued aggressive management of the balance sheet, capital structure and working capital, (f) refinancing the revolving line of credit, which was completed during the first quarter of 2009, and (g) continuing to seek longer-term sources of capital.

		There can be no assurance that actions taken will be sufficient to enable management to mitigate the effects of continuing fragile economic conditions, and other external market conditions which are beyond the control of management. A further worsening of the economy in the United States of America could materially adversely affect the Company’s business, including its results of operations, financial condition and prospects.

		On February 24, 2010, the Company closed a private placement financing transaction, selling 951,500 Units at $2.00 per Unit, each Unit consisting of five shares of restricted Common Stock and two 5-year restricted warrants to purchase one share of Common Stock at $0.70 per share to 71 accredited investors. The total aggregate consideration of the transaction is $1,903,000, with net proceeds of $1,707,600 after underwriting discount and other fees. The Company issued 475,750 five-year warrants to purchase common stock to the placement agent with a strike price of $0.625. The fair value of these warrants is determined using the Black-Scholes option-pricing model with assumptions of 162.1 percent volatility, an expected term of 30 months, expected dividend yield of 0.0 percent and a risk free rate of 1.42 percent resulting in a fair value of $219,661. Although this additional equity strengthened the Company’s capital and liquidity position, economic conditions continue to be very challenging for most industries and many companies.

		During the six months ended June 30, 2010, the Company reported net income of $0.4 million. The Company decreased its short-term borrowings under its new revolving line of credit by $0.5 million and continues to aggressively manage its capital resources.

(4)	Inventories

	A summary of inventories follows:


	June 30, 2010		December 31, 2009
	(unaudited)

Raw materials and supplies	$	2,509,222	$	2,828,026
Finished goods		307,384		226,793


Total inventory	$	2,816,606	$	3,054,819


	June 30, 2010			December 31, 2009
	(unaudited)
Land	$	238,162		$	238,162
Plant and improvements		11,699,376			11,699,376
Machinery and equipment		9,546,498			9,279,686
Transportation equipment		439,750			485,159
Software and office equipment		2,058,635			159,638
Software development		290,516			1,769,898
Construction in progress		38,240			26,641

		24,311,177			23,658,560
Less accumulated depreciation		(8,993,065	)		(7,861,553	)

Property and equipment, net	$	15,318,112		$	15,797,007


	June 30, 2010		December 31, 2009
	(unaudited)
6.75 - 7.10% Cleveland County Industrial Revenue Bonds secured by real property final payment due December 1, 2024	$	3,645,000	$	3,645,000
4.25% Real estate loans secured by real property final payments due August 1, 2028		3,037,154		3,093,666
6.00% Real estate loans secured by real property final payments due September 22, 2010		170,716		178,253
5.25% Equipment loan secured by manufacturing equipment final payment due March 3, 2011		760,224		978,478
Various equipment and real estate loans with interest rates from 4.75 - 9.56% and due dates from 2010-2021		154,460		186,844


Total long-term debt		7,767,554		8,082,241
Less current portion		1,482,231		1,138,602

Net long-term debt	$	6,285,323	$	6,943,639


Year Ending June 30,	Long-Term Debt		Capital Lease Obligations		Total

2011	$	1,482,231	$	11,779	$	1,494,010
2012		550,756		-		550,756
2013		585,939		-		585,939
2014		621,345		-		621,345
2015		656,984		-		656,984
Thereafter		3,870,299		-		3,870,299

Principal outstanding at June 30, 2010	$	7,767,554	$	11,779	$	7,779,333


	June 30, 2010			December 31, 2009
	(unaudited)
Net operating loss carryforward	$	2,895,355		$	3,306,341
Depreciation		(576,837	)		(691,761	)
Deferred gain on sale of assets		9,757			16,571
Inventory capitalization		98,688			95,319
Reserve for worker compensation expense		66,587			29,105
Allowance for credit losses		21,423			40,423
Work opportunity credit carryforward		37,132			37,132
Oklahoma job and investment credits		877,310			877,310
Allowance for state job and investment credits		(789,743	)		(789,743	)

Net deferred tax asset	$	2,639,672		$	2,920,697


Current portion	$	270,924		$	264,772
Non-current portion		2,368,748			2,655,925

	$	2,639,672		$	2,920,697


(5)	Restricted Assets

	The Company is required to hold cash in reserve in separate trust accounts applicable to its $5.0 million Cleveland County Industrial Authority Industrial Development Revenue Bonds, issued December 2004. The project construction account represents proceeds of the bond offering to be drawn for approved capital expenditures. The debt reserve account represents funds to be used for debt service in the event of default. The interest and principal accounts represent deposits to be used for debt service. Letters of credit are amounts placed in deposit with a lending institution for purposes of securing letters of credit. These assets are as follows:


(6)	Property and Equipment

	Property and equipment, at cost, consists of the following:


	During the three months ended June 30, 2010 and 2009, depreciation expense, including depreciation on assets classified as capital leases, was $585,889 and $416,951, respectively. During the six months ended June 30, 2010 and 2009, depreciation expense, including depreciation on assets classified as capital leases, was $1,174,430 and $835,048, respectively.

(7)	Line of Credit

	On March 18, 2009, the Company closed on an asset-based line of credit of up to $3.0 million, secured by accounts receivable and inventories (the “revolving line of credit”). The revolving line of credit bears interest, floating at the Wall Street Journal Prime Rate plus 4.5 percent, and is subject to certain financial covenants, including minimum cash position and EBITDA, measured on a monthly and quarterly basis, respectively, which the Company was in compliance with or has obtained a waiver of compliance as of June 30, 2010. The maximum amount of the line of


	credit was increased to $3.5 million on September 30, 2009 in connection with a modification of terms used to calculate the available borrowing amount and a modification of the covenants. The revolving line of credit matured on May 1, 2010. On April 26, 2010, the Company entered into a second amendment to extend the maturity date to July 1, 2010. On June 25, 2010, the Company entered into a third amendment to extend the maturity date to June 25, 2011 under substantially the same terms. In connection with the revolving line of credit, the Company issued 252,454 warrants to purchase common stock of the Company. The exercise price of the warrants of $0.59 is equal to the weighted average price for the 30 trading days ending on the trading day immediately before delivery. The Company values the warrants using the Black-Scholes option-pricing model and amortizes to expense over the life of the loan. Cash receipts from customers are deposited into a bank account that is subject to an account control agreement, wherein the funds are held for collection – generally one-to-two days – before being applied to balances outstanding under the revolving line of credit. Once the funds are applied to balances outstanding, additional borrowing capacity is created, and funds can be immediately re-borrowed, subject to the other terms of the revolving line of credit agreement. The maximum availability under the line of credit on June 30, 2010 was $3.5 million of which there were short-term borrowings of $1.9 million.

(8)	Long-Term Debt and Capital Lease Obligations

	Long-term debt consists of the following:


	The Industrial Development Revenue Bonds issued by Cleveland County Industrial Authority contain certain financial covenants as follows:

	Debt Service Coverage Ratio: The Company is required to maintain a debt service coverage ratio of 1.50x to 1.00. The ratio will be reported to the Trustee and notice given to Beneficial Owners quarterly for each of the previous four quarters. The actual debt service coverage ratio as of June 30, 2010 is 1.95x to 1.00.

	Current Ratio: The Company is required to maintain a current ratio of 1.10x to 1.00 calculated as of the last day of each calendar quarter beginning after January 1, 2006. The actual current ratio as of June 30, 2010 is 0.74x to 1.00.

	Debt to Equity Ratio: The Company is required to maintain a debt to equity ratio of not more than 4.00x to 1.00 calculated as of the last day of each calendar quarter beginning after January 1, 2006. The actual debt to equity ratio as of June 30, 2010 is 0.72x to 1.00.


	Accounts Payable: The Company agrees that not more than 10 percent of its accounts payable shall be in excess of 75 days past due. The actual percentage as of June 30, 2010 is 0.48 percent.

	Accounts Receivable: The Company agrees that not more than 20 percent of accounts receivable will be in excess of 90 days past due. The actual percentage as of June 30, 2010 is 0.08 percent.

	Capital lease obligations consist of the following:


	June 30, 2010 (unaudited)		December 31, 2009

8.95 - 9.19% Equipment leases	$	11,779	$	94,479
Less current portion		11,779		94,479

Net long-term debt	$	-	$	-


	During the the three months ended June 30, 2010 and 2009, total interest costs were $207,488 and $289,350, respectively. During the the six months ended June 30, 2010 and 2009, total interest costs were $476,670 and $515,880, respectively.

(9)	Accrued Liabilities

	A summary of accrued liabilities follows:


(10)	Intangible Assets

	The Company holds an intangible asset, a customer list acquired by the Company in the amount of $154,210. The Company began amortizing the asset to expense over a period of five years beginning July 1, 2007, resulting in amortization expense of $7,712 in each of the three month periods ended on June 30, 2010 and 2009. As of June 30, 2010, accumulated amortization expense was $92,544 and the net carrying amount was $61,666.

(11)	Income Taxes

	Income tax expense (benefit) for the three months and six months ended June 30, 2010 and 2009, consist of the following:


	The Company is not currently subject to any specific audit by any federal, state or local taxing authority. The Company is no longer subject to income tax examinations by tax authorities before 2005. There are no tax positions previously taken which could give rise to uncertainty, and therefore there are no calculations or classifications of interest, penalties or effects on income tax rates related to such uncertainties

	As of June 30, 2010, the Company has a net operating loss carryforward of $7.6 million representing a tax asset of $2.9 million which, if unused, will commence expiring in 2023 and state new jobs/investment credit carryforwards totaling $877,000 of which the Company has elected to provide a realizability allowance of $789,000 resulting in a net carrying amount of $88,000. If unused, the credits will commence expiring on December 31, 2021.

	Actual income tax expenses differ from “expected” income tax, computed by applying the U.S. Federal corporate tax rate of 34 percent to earnings from operations before income taxes, as follows:


(12)	Operating Leases

	The Company has noncancelable long-term operating leases for certain distribution equipment with various expiration dates, one lease for refrigerated warehouse space and one lease for office equipment. The equipment leases require the Company to pay a base rate plus specific mileage amounts. Future minimum annual lease payments for these long-term leases for the next five years ending June 30,


	(unaudited)
2011	$	517,966
2012		309,455
2013		169,595
2014		19,971
2015		-

	$	1,016,987


(13)	Stock Based Compensation

	In August 2006, the Company adopted the 2006 Equity Incentive Plan (the “Plan”) providing for potential awards of up to 1,000,000 options to purchase shares of common stock in the Company. On November 26, 2008, the Compensation Committee of the Board of Directors of the Company approved a proposal by management to issue stock options under the Plan to certain employees, directors and consultants of the Company or a Subsidiary. On March 12, 2009, 14,120 incentive stock options were issued on substantially the same terms as the incentive stock options issued on November 26, 2008. Except as noted below, options shall have a 10-year term, and shall vest at 25% per year, commencing on the first anniversary of the grant date. The grant date was November 26, 2008, and the exercise prices are equal to the closing market price on November 25, 2008 ($0.69), except for owners of 10% or more of the total shares of the Company. Exercise prices for the 10% and greater owners are 110% of the closing market price on November 25, 2008 ($0.76) and the options (i) have a term of five (5) years and (ii) vest at the rate of 25% per year. In all cases, the options shall immediately vest upon a Change in Control of the Company, as defined in the Plan. All options granted to employees are intended to qualify as Incentive Stock Options, as defined by Section 422 of the Internal Revenue Code of 1986, as amended, and the stock options granted to non-employee directors and consultants to the Company or a Subsidiary will be Nonqualified Stock Options as provided for in the Plan. The Company uses the Black-Scholes method of valuing the options and charges amounts to earnings using the straight-line method over the vesting period. The Company charged $22,484 and $21,874 against earnings


	during the three months ended June 30, 2010 and 2009, respectively. The Company charged $44,967 and $43,949 against earnings during the six months ended June 30, 2010 and 2009, respectively, leaving a total of $212,881 of unrecognized expense in connection with the issuance of the stock options.

(14)	Major Customers

	The Company has two major customers which comprise 15 percent and 10 percent of its sales. A change in either of these customer relationships could adversly affect our revenue, results of operations and cashflows.

(15)	Commitments and Contingencies

	The Company and its subsidiaries are subject to legal proceedings and claims which arise in the ordinary course of business. Although occasional adverse decisions or settlements may occur, the Company is not aware of any proceeding at June 30, 2010, which would have a material adverse effect on its consolidated financial position, results of operations or liquidity.

(16)	Insurance Proceeds from Weather Related Damage

	During the second quarter of 2010, the company’s primary manufacturing facility sustained damaged due to adverse weather. The company has received a settlement proposal and a check for $0.6 million from its insurance carrier, but has not accepted the proposal nor tendered the check. Acceptance of the insurance proceeds for the purpose of repairing the damage requires the consent of the mortgage holders on the real estate, and such consent has been sought and is pending. Management believes that consent of the mortgage holders is reasonably assured. The settlement of this transaction, including the facility repairs after application of the insurance proceeds, is not expected to have a material effect on the company’s financial position or results of operations. For reasons mentioned above, the proposed settlement proceeds of $0.6 million have not been recorded in the accompanying consolidated financial statements.

(17)	Note Payable to Former Owners of Allisons Gourmet Kitchens, LP

	The Company has a note payable to Herbert B. Grimes, its current chief executive officer in the amount of $880,909 due on September 30, 2010 with interest rate of 10 percent per annum. Mr. Grimes has agreed that repayment of the note is subject to the Company’s ability to pay as measured by its liquidity position, projected cash flows and EBITDA.


	•	our future operating results and the future value of our common stock;

	•	our ability to obtain financing to fund our operations;

	•	whether our assumptions turn out to be materially correct;

	•	our ability to attain such estimates and expectations;

	•	our ability to execute our strategy;

	•	further material changes in market conditions in any industry, including the economic state of the food industry;

	•	the effects of, or further material changes in, economic and political conditions in the United States of America and the markets in which we serve;

	•	our ability to reasonably forecast prices of the commodities we purchase;

	•	our ability to timely forecast and meet customer demand for fresh-cut salads and refrigerated prepared salads;

	•	our ability to respond to changing consumer spending patterns,

	•	our ability to attract and retain quality employees and control our labor costs; and

	•	our ability to provide products that are safe for human consumption


Exhibit No.		Description


10.1		Promissory Note by Vaughan Foods, Inc. to Herbert B. Grimes.

31.1		Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes Oxley Act of 2002.

31.2		Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a) or 15d-14(a), as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certifications of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


	Vaughan Foods, Inc.

	By:	/s/ Herbert B. Grimes

		Herbert B. Grimes
		Chairman of the Board of Directors and
		Chief Executive Officer

		(Principal Executive Officer)
Dated: August 16, 2010


	Vaughan Foods, Inc.

	By:	/s/ Gene P. Jones

		Gene P. Jones
		Chief Financial Officer
		(Principal Financial Officer)


I, Herbert B. Grimes, certify that:

(1)	I have reviewed this quarterly report on Form 10-Q of Vaughan Foods, Inc.;

(2)	Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

(3)	Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

(4)	The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

	a.	Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	b.	Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

	c.	Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	d.	Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

(5)	The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

	a.	All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	b.	Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.


Date: August 16, 2010	/s/ Herbert B. Grimes

	Herbert B. Grimes
	Chairman of the Board of Directors and Chief Executive Officer
	(Principal Executive Officer)