Note 6 - Notes Payable

The recorded value of our notes payable (net of debt discount) for the nine months ended September 30, 2011 and year ended December 31, 2010 was as follows:

	December 31, 2010			September 30, 2011

Amended and Restated Senior 6.25% Convertible Note	$	6,180,816		$	6,180,816
Unsecured Convertible Note		7,168			257,170
Pledged A/R Note Payable		675,000			--
Short Term Note Payable		100,000			--
Total		6,962,984			6,437,986
Less Current Portion		(775,000	)		(171,875	)
Total Long-term	$	6,187,984		$	6,266,111

Amended and Restated Senior 6.25% Convertible Note

On December 24, 2007, we entered into a securities purchase agreement in which we raised $15,000,000 (less $937,000 of prepaid interest). We used the proceeds from this financing to support our CodecSys commercialization and development and for general working capital purposes. Pursuant to the financing, we issued a senior secured convertible note in the principal amount of $15,000,000. The senior secured convertible note bore interest at 6.25% per annum if paid in cash. Interest for the first year was prepaid at closing. Interest-only payments thereafter in the amount of $234,375 were due quarterly and commenced in April 2009. The original principal of the note was convertible into 2,752,294 shares of our common stock at a conversion price of $5.45 per share, convertible any time during the term of the note. We granted a first priority security interest in all of our property and assets and of our subsidiaries to secure our obligations under the note and related transaction agreements.

In connection with the 2007 financing, the senior secured convertible note holder received warrants to acquire 1,875,000 shares of our common stock exercisable at $5.00 per share. We also issued to the convertible note holder 1,000,000 shares of our common stock valued at $3,750,000 and incurred an additional $1,377,000 for commissions, finders fees and other transaction expenses, including the grant of a three-year warrant to purchase 112,500 shares of our common stock to a third party at an exercise price of $3.75 per share, valued at $252,000. A total of $1,377,000 was included in debt offering costs and was amortized over the term of the note.

From March 26, 2010 through October 29, 2010, we entered into a series of amendments to the senior secured convertible note under which we issued to the holder of the senior secured convertible note an additional 3,000,000 shares of our common stock, increased the number of warrants by 3,333,333 shares, and reduced the warrant exercise price to $1.80 per share for all warrants, all as consideration for the amendments.

On December 24, 2010, we closed on the Debt Restructuring (as defined below). In connection therewith, we (i) issued an Amended and Restated Senior Convertible Note in the principal amount of $5.5 million (the "Amended and Restated Note") to Castlerigg Master Investment Ltd. ("Castlerigg"), (ii) paid $2.5 million in cash to Castlerigg, (iii) cancelled warrants previously issued to Castlerigg that were exercisable for a total of 5,208,333 shares of common stock, (iv) issued 800,000 shares of common stock to Castlerigg in satisfaction of an obligation under a prior loan amendment, (v) entered into a Letter Agreement pursuant to which we paid Castlerigg an additional $2.75 million in cash in lieu of the issuance of $3.5 million in stock and warrants as provided in the loan restructuring agreement under which the Amended and Restated Note and other documents were issued (the "Loan Restructuring Agreement"), and (vi) entered into an Investor Rights Agreement with Castlerigg dated December 23, 2010. As a result of the foregoing, Castlerigg forgave approximately $7.2 million of principal and accrued but unpaid interest. The Debt Restructuring was considered a troubled-debt restructuring and a gain on debt restructuring of $3,062,457 was recorded during the year ended December 31, 2010, which was the difference between the adjusted carrying value of the original note and the carrying value of the Amended and Restated Note.

The Amended and Restated Note, dated December 23, 2010, is a senior, unsecured note that matures in three years from the closing and bears interest at an annual rate of 6.25%, payable semi-annually. We paid the first year's interest of $350,434 at the closing. The Amended and Restated Note is convertible into shares of common stock at a conversion price of $1.35 per share, subject to adjustment. The Amended and Restated Note is convertible in whole or in part at any time upon notice by Castlerigg to us. The Amended and Restated Note also contains various restrictions, acceleration provisions and other standard and customary terms and conditions. Two of our consolidated subsidiaries guaranteed our obligations under the Amended and Restated Note.

The Investor Rights Agreement provides Castlerigg with certain registration rights with respect to the Company's securities held by Castlerigg. These registration rights include an obligation of the Company to issue additional warrants to Castlerigg if certain registration deadlines or conditions are not satisfied. The agreement also contains full-ratchet anti-dilution price protection provisions in the event the Company issues stock or convertible debt with a purchase price or conversion price less than the conversion price described above.

As of September 30, 2011 and 2010, we recorded an aggregate derivative liability of $203,700 and $1,000,500 respectively, related to the conversion features of the Amended and Restated Note and the conversion feature and warrants related to the Original Note. A derivative valuation gain of $2,403,700 and loss of $235,200 was recorded during the nine months ended September 30, 2011 and 2010, to reflect the change in value of the aggregate derivative liability since December 31, 2010 and 2009, respectively. The aggregate derivative liability of $203,700 for the Amended and Restated Note conversion feature was calculated at September 30, 2011 using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate of 0.25%, (ii) expected life (in years) of 2.2; (iii) expected volatility of 68.80% for the conversion feature, (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.45.

During the nine months ended September 30, 2010, the principal value of the 6.25% senior secured convertible note was increased by $1,131,836 to $17,528,086 (convertible into 9,737,826 common shares), for interest capitalized rather than making a payment in cash.

The original principal value of the note was being accreted over the term of the obligation, for which $1,047,825 and $3,143,475 was included in interest expense for the three and nine months ended September 30, 2010. The note now bears a 6.25% annual interest rate payable quarterly and for the nine months ended September 30, 2010, $27,388 was accrued and included as interest expense. For the nine months ended September 30, 2010, $1,106,217 ($1,131,836 offset by $25,619 note interest accrued in 2009) was included in interest expense for capitalized interest.

The $6,180,816 value of the note at September 30, 2011 consists of $5,500,000 for the principal due of the note plus $1,031,250 for aggregate future interest less $350,434 for interest withheld at closing for interest due from the initial date of the debt restructuring transaction until December 31, 2011.

Unsecured Convertible Note

On September 29, 2006, we entered into a letter of understanding with Triage Capital Management, or Triage, dated as of September 25, 2006. The letter of understanding provided that Triage loan $1,000,000 to us in exchange for us entering into, on or prior to October 30, 2006, a convertible note securities agreement. It was intended that the funding provided by Triage be replaced by a convertible note and accompanying warrants, as described below. Effective November 2, 2006, we entered into securities a purchase agreement, a 5% convertible note, a registration rights agreement, and four classes of warrants to purchase our common stock, all of which were with an individual note holder, the controlling owner of Triage, who caused our agreement with Triage to be assigned to him, which satisfied our agreement with Triage.

Pursuant to the securities purchase agreement, (i) we sold to the convertible note holder a three-year convertible note in the principal amount of $1,000,000 representing the funding received by us on September 29, 2006; (ii) the convertible note bore an annual interest rate of 5%, payable semi-annually in cash or shares of our common stock; (iii) the convertible note was convertible into shares of our common stock at a conversion price of $1.50 per share subject to full-ratchet anti-dilution price protection provisions ; and (iv) we issued to the convertible note holder four classes of warrants (A Warrants, B Warrants, C Warrants and D Warrants), which give the convertible note holder the right to purchase a total of 5,500,000 shares of our common stock as described below. The A and B Warrants originally expired one year after the effective date of a registration statement filed under the Securities Act of 1933, as amended (the "Securities Act"), to register the subsequent sale of shares received from exercise of the A and B Warrants. The C Warrants and D Warrants originally expired eighteen months and twenty four months, respectively, after the effective date of a registration statement to be filed under the Securities Act. The A Warrants grant the convertible note holder the right to purchase up to 750,000 shares of common stock at an exercise price of $1.60 per share, the B Warrants grant the convertible note holder the right to purchase up to 750,000 shares of common stock at an exercise price of $1.75 per share, the C Warrants grant the convertible note holder the right to purchase up to 2,000,000 shares of common stock at an exercise price of $2.10 per share, and the D Warrants grant the convertible note holder the right to purchase up to 2,000,000 shares of common stock at an exercise price of $3.00 per share.

During the year ended December 31, 2007, the convertible note holder exercised 454,000 A Warrants. We entered into an exchange agreement dated October 31, 2007 in which the convertible note holder received 650,000 shares of our common stock in exchange for cancellation of the C and the D Warrants. The expiration date of the A Warrants and the B Warrants was extended from January 11, 2008 to December 3, 2008. During the year ended December 31, 2008, the convertible note holder exercised 64,400 A Warrants. On December 3, 2008, the remaining 231,600 A Warrants and 750,000 B Warrants expired.

On December 23, 2009 we entered into an amendment with the holder of this unsecured convertible note, which (i) extended the note maturity date to December 22, 2010 and (ii) increased the annual rate of interest from 5% to 8% commencing October 16, 2009. All other terms and conditions of the note remained unchanged.

On December 24, 2010 we closed on a Debt Restructuring as mentioned above. In connection with that Debt Restructuring the Company amended the note with the holder of a $1.0 million unsecured convertible note, pursuant to which the maturity date of the note was extended to December 31, 2013. We issued 150,000 shares to the holder of this note as consideration to extend the term of the note.

During March 2011, we issued 135,369 shares of common stock to the holder of our unsecured convertible note in satisfaction of $81,221 of accrued interest on the unsecured convertible note. Also in connection with the satisfaction of the accrued interest we granted to the holder a warrant to acquire up to 221,758 additional shares of our common stock at an exercise price of $0.96 per share. The warrant is exercisable at any time for a five-year period. For the nine months ended September 30, 2011, the $157,400 value of the warrant was included in interest expense.

At September 30, 2011 and 2010 we recorded an aggregate derivative liability of $256,700 and $2,800, respectively, related to the conversion feature of the note. A derivative valuation gain of $1,145,200 and $197,200, respectively, was recorded to reflect the change in value of the aggregate derivative liability since December 31, 2010 and December 31, 2009, respectively. The aggregate derivative liability of $256,700 for the conversion feature of the note was calculated using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate 0.25%, (ii) expected life (in years) of 2.3; (iii) expected volatility of 73.43%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.45.

In connection with the amendment mentioned above, the principal value of the note will be accreted due to the difference in the value of the conversion feature before and after the amendment. The accretion for the three and nine months ended September 30, 2011, was $83,334 and $250,002, respectively and was included in interest expense. The note currently bears an 8% annual interest rate payable semi-annually, and for each of the three and nine month periods ended September 30, 2011 and 2010, $20,000 and $60,000, respectively was included in interest expense.

Accounts Receivable Purchase Agreements

During the year ended December 31, 2010 we entered into two Accounts Receivable Purchase Agreements with one individual for an aggregate amount of $775,000. In these agreements, we pledged certain outstanding accounts receivable in exchange for advanced payment and a commitment to remit to the purchaser the amount advanced upon collection from our customer. Terms of the first agreement under which we were advanced $175,000 include a 3% discount with a 3% interest fee for every 30 days the advances remain outstanding. Terms of the second agreement under which we were advanced $500,000 include a 10% discount with a 0.5% interest fee for every 30 days the advances remain outstanding.

During the three months ended March 31, 2011 we converted the remaining $675,000 of principal along with $109,292 of accrued and unpaid interest into 1,307,153 shares of our common stock and warrants to purchase an additional 653,576 shares of our common stock. The warrants contain anti-dilution price protection provisions in the event the Company issues stock or convertible debt with a purchase price or conversion price less than $1.00 per share.

At September 30, 2011 we recorded an aggregate derivative liability of $135,500 related to the warrant reset provision. A derivative valuation gain of $314,600 was recorded to reflect the change in value of the aggregate derivative liability from the time the warrants were issued. The aggregate derivative liability of $135,500 for the reset provision of the warrants was calculated using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate 0.83%, (ii) expected life (in years) of 4.5; (iii) expected volatility of 81.42%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.45.

Short Term Note Payable

During the three months ended March 31, 2011 we remitted $100,000 of the principal balance and accrued interest of $8,360 to a company pursuant to a short term note. The note had originated in June 2010 and bore an annual interest rate of 12%. Of the $8,360 of interest paid, $2,327 was related to and included in interest expense for the nine months ended September 30, 2011.